David Olson

FOCUS ISSUE FOR THE WEEK

We now have had two disastrous weeks in a row.  Two weeks ago the S&P downgrade led to the collapse of the stock market, which somehow recovered a bit by the end of the week before heading down again this week.  Investors ran for cover to the U.S. bond market causing rates to plummet rather than rise as expected.  This past week there was a veritable cascade of bad economic reports from every sector and Europe.  All economists have lowered their forecasts and many more are calling for a double dip.  A typical forecast is for the second half of this year to be a repeat of the mediocre first half.  Many indicators hit new lows this week and there was an impending feeling in the air that the economy will continue to head downwards as Washington ran out of ideas and the president and Congress headed off for vacation.

MORTGAGE MARKET SUMMARY

The MBA’s mortgage application index rose 4.1% this week after rising 21.7% the prior week.  The seasonally adjusted Refinance Index increased by 8.0% from the previous week.  The seasonally adjusted Purchase Index saw the only decrease for the week, falling by 9.1% from one week earlier.   Mortgage rates are at all time lows.   The DJIA fell 4.2% to 10,818 on August 19 from closing on August 12 at 11,269.  For the week there were 11 positive trends offset by 24 negative trends.

Positive Trends

• Industrial Production rose 0.9% in July after rising 0.4% in June reported the Federal Reserve.  This was higher than expected.  Capacity utilization rose to 77.5% in July, up from 76.9% in June.  Manufacturing production rose 0.6% from June.

• In second quarter 2011, home prices across the U.S. fell only 0.4% from the first quarter reported Zillow.  This was the lowest decline in more than four years.

• The average yield for the 30 YFRM fell to an all-time low of 4.15% according to the Freddie Mac survey for the week ending August 18.  That is down from 4.32% the prior week.  This has led to a wave of refinances but no increase in purchase money loans.  Home purchase mortgages were down 9.1% last week from the previous week.  NAR Chief economist Lawrence Yun said the fallout rate of contract sales for properties on the market continued to average 16% for a second straight month, higher than the 10% average seen during the same period in 2010. The uptick was a result of difficulties with mortgage financing and home appraisals, he said.

• The yield on the ten-year Treasury fell below 2.00% on August 18, hitting an all time low reflecting the disappointing news on unemployment and inflation.  The rate bounced back quickly to 2.05%.  This is down from 2.25% last week.  There has been a flight to cash worldwide reflecting the U.S. debt-ceiling debacle, Europe’s sovereign debt crisis, and poor prospects for global growth.  By August 19, the rate was back to 2.06%.

• Zillow reported that from 1985 to 2000 the average ratio of home prices to incomes was 2.9. In 2010 the ratio was 3.3 after peaking at 5.1 in 2005.  That means the popping of the property bubble is almost over. One-third of U.S. cities are now below their long term average level.  The worst are Detroit and Las Vegas.

• Home ownership beats renting in 74 percent of 50 major U.S. cities included in Trulia’s Summer 2011 Rent vs. Buy Index, which compares the cost of buying and renting a two-bedroom apartment, condo or townhouse. Joining Las Vegas in the top five cities are Detroit; Mesa, Ariz.; Fresno, Calif.; and Arlington, Texas.  Las Vegas came in with a price-to-rent ratio of 6, based on Trulia’s median list price of $58,000 divided by $9,700 for 12 months of rent, or about $800 a month.

• Banks loosened credit standards on most types of loans in the second quarter, with commercial and industrial lenders citing “aggressive competition” as a reason for the easier terms, according to a Federal Reserve survey. A “modest” increase in demand for commercial and industrial loans was also reported over the last three months, the Fed said.  Commercial and industrial loans totaled $1.28 trillion for the week ending Aug. 3, according to a separate Fed report. That was up from $1.27 trillion for the week ending July 27. Loans to consumers came to $1.09 trillion, little changed from the prior week.  On the consumer front, banks said standards on home mortgages were little changed for both prime and non-traditional loans during the second quarter. In addition, about three-quarters of banks said they expected the pace of mortgage lending “to remain at about the same level through the rest of 2011,” the Fed said.  The banks cited “reduced or unchanged demand from creditworthy borrowers” as a factor. They also pointed to “unfavorable or uncertain forecasts for the broad economy and for house prices.

• Leading indicators rose 0.5% in July after rising 0.3% in June.

• The U.S. Department of Agriculture has only two months to spend $11.2 billion on its no-down payment rural development loan program, a record amount at this juncture in the federal fiscal year for the program that provides no-down payment mortgages to borrowers in rural and suburban markets.
• Fitch Ratings affirmed its AAA credit rating for the U.S. and said the outlook is stable, citing the nation’s central role in the global financial system and the flexible, diverse economy.

• Ellie Mae both lowered its profit prediction while at the same time announcing that it had purchased Del Mar DataTrac for $17.2 million in cash, in addition to future cash payments of $8 million total over the next three years. “The goal will be integrating Del Mar’s DataTrac software with Ellie’s own Encompass product, resulting in significant costs, and Ellie Mae will support both DataTrac product and service offerings and existing Encompass solutions and services.”

Negative Trends

• Existing homes sales fell 4.67% in July to a 4.67 million annual rate, down from 4.84 million in June reported the National Association of Realtors. This was lower than expected and is the lowest level since last November.  For the month, inventories rose to 9.4 months up from 9.2 months in June.  The average sales price was $174,000, down 4.4% from a year ago.

• Housing starts fell to a 604,000 level in July, down from 613,000 in June reported the Census Bureau. This was close to what was expected.  The housing market continues to be weak.  Housing permits decreased to a 597,000 annual pace. They were projected to fall to a 605,000 annual rate from 617,000 the prior month, according to the survey median.

• The Empire Manufacturing index fell to -7.7 in August, after being at -3.76 in July. Any reading below zero means a contraction.  The index has now been in negative territory for the past three months.  The index measures manufacturing activity in New York state.

• The Philadelphia Federal Reserve’s business index plummeted to -30.7 in August.  In July it had been 3.2%.  This was a crash in all sectors of the economy. That was the lowest level since reaching -30.8 in March 2009.  The market was expecting only a small decline.

• Initial claims for unemployment rose to 408,000 the week ending August 13 after being down to 399,000 the prior week.  This isn’t a good sign for the economy.  However, the four-week moving average continued to decline to 403,000 this past week from 406,000 the prior week.  Continuing claims rose to 3,702,000 for the week ending August 6 from 3,695,000 the prior week.  Again this is a sign of weakness.

• In July, producer prices rose 0.2% after declining 0.4% in June. The core PPI rose 0.4%, up from a 0.3% increase in June.  Prices are up 7.2% year-over-year.
• The CPI rose 0.5% in July, up from -0.2% in June.  This is much higher than forecast by most economists.  Year-over-year, the CPI is up 3.6%.  This is higher than the Fed likes so will likely constrain them from buying more government bonds in a quantitative easing.  The core CPI only rose 0.2%.  Average weekly wages in July were 1.3% lower than their recent peak in October 2010.

• This week gold had another flight-to-safety rush at it rose 6.1% to $1,849 an ounce, easily a new nominal record.

• Basel III will require roughly 30 of the world’s top banks to hold between 1% and 2.5% of extra capital as a percentage of their “risk-weighted assets.” That comes on top of a base 7% capital requirement for all banks that international policy makers agreed to last year.  This new requirement applies only to banks deemed to be too big to fail.  It doesn’t apply to smaller banks.    Regulators hope the new rules, which will kick in gradually over the next seven years, will discourage bankers from imprudent risk taking and ensure that giant institutions can absorb sudden losses without imperiling the global financial system or requiring taxpayer bailouts.  In the U.S. it applies to Bank of America, Chase, Citi, and Wells.

• The QRM (Qualified Regulated Mortgage) proposal would require lenders to retain 5% of the value of loans they originate (for loans that are securitized, excluding Fannie and Freddie) unless the loans have at least 20% down according to the Wall Street Journal. If they meet that down payment requirement and other stiff underwriting requirements, the 5% risk retention requirement is waived, so these loans will be far more affordable than loans for which the standards aren’t met.  In fact, the pricing difference could be as high as 225 basis points, NAR Research estimates.  Should interest rates rise later this year, home sales could be hit hard.  With a minimum 20% down required for loans to qualify for the 5% exemption, the vast majority of borrowers will have to go for the more expensive financing — assuming they can even afford that financing.  QRM is just one regulation included in the Dodd-Frank Act.  The comment period on QRM regulations ended August 1, but Federal Reserve has not yet released the date when the regs would be published.  Virtually all the mortgage and real estate industry associations vigorously oppose this regulation.  The upshot is that if credit continues to shrink, home prices must decline in response.  Chris Whalen of Institutional Risk Analytics wrote on March 29 that “While the media will be fascinated by all of this insider play over the “QRM”, the real story is out in the housing market, where more than half of all home sales this year will be involuntary foreclosure liquidations.  The slow erosion of home prices is likewise eating away at the willingness of lenders to take risk in real estate, thus the 4% decline in loan balances YOY according to the FDIC.”

• GDP in France in 2Q11 was zero. In Japan it was -0.3% which was less a decline than expected.  In the U.S. it was 1.3%, a slower rate of growth than expected.  A report showed European economic growth slowed more than forecast in the second quarter as Germany’s recovery almost ground to a halt amid the worsening sovereign-debt crisis. GDP in the 17-nation euro area rose 0.2% from the first quarter, the worst performance since the euro region emerged from a recession in late 2009. Economists had forecast growth of 0.3 percent, according to the median of estimates in a Bloomberg News survey.  U.S. stocks fell on the news.  Slow growth is now expected in many parts of the world.  This will slow U.S. exports.  Roubini warns of a worldwide recession.  Europe’s low growth outlook will make it difficult for them to refinance the government debts in Italy and Spain.

• Risk premiums on high-yield debt in the secondary market on August 12 rose to an average of 7.39 percentage points over comparable Treasuries. This high price for risk occurs during recessions.  During the 1990-91 recession, the risk premium was 7 to 10 percentage point range.  In 2001 it was 8 to 10 percentage points.

• Total loans and leases at commercial banks as of July 27 were down 0.4% from 2010 according to the Federal Reserve. This suggests a weak economy despite extremely low rates of interest.

• As of August 12, the S&P 500 stock index was trading at 10.6 times projected earnings for the next 212 months reported Capital IQ.  This is well below the historical average P/E of 17 times.

• Net dollar flows into U.S. stock mutual funds peaked in 2000 and have been lackluster since then, according to the Investment Company Institute. Over the past five weeks, investors have been taking money out of the stock market.  This suggests lack of confidence in stocks.  The rich in America have traditionally been more optimistic about the economy than everyday investors. Yet current surveys show the rich are among the most pessimistic about the economy. Rather than investing in stocks or companies that can create jobs, they are betting on continued volatility and slow growth

• The National Association of Home Builders Housing Market Index remained in August at 15, unchanged from its level in July.  Housing isn’t recovering yet.  The component measuring sales expectations for the next six months declined two points.

• Bankruptcy filings increased +2,600 this past week over the prior week to 30,109.  The 4-week moving average increased +2,500 to 26,570.

• Mortgage fraud saw continued elevated levels in 2010, sustained from 2009, says the latest FBI report on mortgage fraud. Reverse mortgages are included among the prevalent mortgage fraud schemes reported, with Fannie Mae reporting that current reverse mortgage fraud schemes include the use of asset misrepresentation, occupancy fraud, and identity theft.  While total dollar losses due to mortgage fraud are unknown, perpetrators include licensed/registered and non-licensed/registered mortgage brokers, lenders, appraisers, underwriters, accountants, real estate agents, settlement attorneys, land developers, investors, builders, bank account representatives, and trust account representatives, according to the FBI.

• A report from Experian, Costa Mesa, Calif., said American consumers are doing a better job of managing their personal finances in nearly every area–except for mortgage payments. The report said nationally since 2007, as the recession kicked in, consumers made 20% fewer credit card payments 60 days or late. However, during the same period Experian reported 25% more consumers made their mortgage payments 60 days or later.

• President Obama has directed a small team of advisers to develop a proposal that would keep the government playing a major role in the nation’s mortgage market, extending a federal loan subsidy for most home buyers, according to people familiar with the matter.  The decision follows the advice of his senior economic and housing advisers, who favor maintaining the government’s role as an insurer of mortgages for most borrowers. The approach could even preserve Fannie Mae and Freddie Mac, the mortgage finance giants owned by the government, although under different names and with significant new constraints, said people knowledgeable about the discussions.

• Lowe’s cut back its outlook for future sales as consumers turned to smaller projects. The average cost of order declined 0.9% this past quarter, causing same-store sales to slip 0.3%.

• Import prices in the U.S. rose 14% year over year in July, reported the Labor Department.

• Stock prices fell 4% to 6% in European markets on August 18. This was the biggest decline in over 4 years.  Bank stocks fell the furthest with Societe General down 12%.

• Bank of America is cutting 3,500 jobs in the current quarter and working on a broader restructuring that could eliminate thousands of additional positions reported the Wall Street Journal. They are laying people off to cut costs even though they have huge backlogs of orders for refinancing mortgages.

CONCLUSION: The Dow Jones Industrial Average is now down 14.4% from its peak this year at 12,876 on May 2.  The Fed can’t interject more stimulus (QE3) because of rising inflation.  Obama says he has a plan to create jobs but is waiting until September to announce it.  There is little likelihood increased government spending will be approved by the Republicans.  We appear to be waiting out a very weak economic future until the elections in November 2012.  That means the GDP annualized growth rate will be around 1% in the near term.

Access Mortgage Research was founded in 1991 to provide research to the mortgage industry. For more details see www.accessmrc.com or phone 410-772-1161.