Freddie Mac – The Daily Tearsheet

Morning Report: Stocks fall on pessimistic FOMC minutes

Vital Statistics:

	Last	Change
S&P futures	3357	-16.6
Oil (WTI)	42.54	-0.32
10 year government bond yield		0.65%
30 year fixed rate mortgage		2.89%

Stocks are down this morning after the Fed minutes revealed pessimism about the economy. Bonds an MBS are up.

Initial Jobless Claims rose back above the 1 million market last week.

The Fed released its minutes from the July FOMC meeting yesterday. The big revelation was a moderating of economic expectations into the end of the year. The money quote: (note this is from the staff economists)

The projected rate of recovery in real GDP, and the pace of declines in the unemployment rate, over the second half of this year were expected to be somewhat less robust than in the previous forecast.

There was also discussion about the concept of yield caps, in other words the Fed targeting specific maturities in the Treasury market to keep the 10-year or 5-year bond yield below a certain target level.

A majority of participants commented on yield caps and targets—approaches that cap or target interest rates along the yield curve—as a monetary policy tool. Of those participants who discussed this option, most judged that yield caps and targets would likely provide only modest benefits in the current environment, as the Committee’s forward guidance regarding the path of the federal funds rate already appeared highly credible and longer-term interest rates were already low.

This is generally good news, at least for those that still cling to the idea that interest rates should be determined by a market. Still, the Fed and the US continues its “slouching towards Japan” strategy. Given the theory that increases in government debt as a percentage of GDP creates sluggish growth and low rates, not inflation (certainly borne out in Japan and Europe), low rates may be around for quite some time.

Mortgage Applications decreased 3.3% last week as rates rose. The purchase index rose by 1%, while refis fell by 5%. “Positive economic data reported last week on retail sales, as well as a large U.S. Treasury auction, drove mortgage rates to their highest level in two weeks,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The rise in rates dampened refinance activity, but purchase applications continued their strong run and were 27 percent higher than a year ago – the third straight month of year-over-year increases.”

There were a lot of rumors going around that the GSEs are looking to delay the 50 basis point LLPA for mortgage refinances. The industry has been dead set against it, and we have seen bipartisan opposition to it. The industry’s main gripe is the short fuse: loans that were locked before the announcement but expected to close after would require the lender to eat the additional cost. A longer runway (say Jan 1) would prevent this. Another option is to apply the LLPA on locks after Sep 1. The word on the street is that the next shoe to drop will be investment properties, so we could see higher LLPAs there in the future.

Fannie CEO Hugh Frater and Freddie CEO David Brickman threw cold water on that idea in a blog post.

Contrary to much of the criticism we have received since making this announcement, this will generally not cause mortgage payments to “go up.” The fee applies only to refinancing borrowers, who almost always use a refinancing to lower their monthly rate…

Some have asserted that this price adjustment could impact borrowers by as much as $1,500—but this life of the loan estimate is a misrepresentation of how this cost would be applied. For an average refinanced mortgage, we estimate a reduction in savings of about $15 per month, meaning refinancing homeowners who were previously saving $133 on their monthly payments will now save $118 per month, on average.

This estimate also assumes lenders pass on the entire fee to borrowers. That is up to them. If they do not, the $15-per-month figure would go down, potentially to zero.

Does this sound like someone reconsidering the idea? It sounds more like “I am altering the deal. Pray I don’t alter it any further.”

Despite the economic gloom, renting households are making their rent payments, according to the National Multifamily Housing Council. Almost 87% of renters have paid August rent, which is down about 2% from a year ago. Note that NYC is bringing up the rear at a sub-80% rate. Writer James Altucher wrote an interesting essay about why this time is indeed different for NYC.

Morning Report: The government hires and advisor for Fannie and Freddie

Vital Statistics:

	Last	Change
S&P futures	3289	43.25
Oil (WTI)	51.38	1.02
10 year government bond yield		1.59%
30 year fixed rate mortgage		3.63%

Stocks are higher after Chinese markets held up overnight. Bonds and MBS are down.

Construction spending fell 0.2% in November, but was up 5% on a YOY basis. Residential construction was up 1.4% MOM and up 5.8% YOY. Public residential construction was up almost 30% YOY.

Manufacturing performed better than expected in January, with the ISM Manufacturing Index rising to 50.9. This is a sharp rebound from December, which indicates that trade issues are in the rear view mirror.

The government is considering an expansion of the Federal Home Loan Bank’s customer base to include non-bank lenders and mortgage REITs. Federal Home Loan Bank borrowers generally get a sweetheart deal on financing, usually much better than even overnight repo lines. The reason? government subsidies. Note that some mortgage REITs currently do have FHLB lines, but I guess they want more mortgage REITs in the business. The Feds have been frustrated by the large banks, who have shied away from all but the most credit-worthy borrowers.

FHFA has hired an advisor to help recapitalize Fannie Mae and Freddie Mac. Houlihan Lokey won the deal. This will allow Fan and Fred to hire their own advisors for the equity sale. This is part of the government’s plan to decrease its footprint in the mortgage market. The share sale could top $125 billion, which would dwarf the largest IPO ever (Saudi Aramco in December) by a factor of 5. Lots of details remain, but progress is being made.

Morning Report: Fannie and Freddie are interviewing investment banks

Vital Statistics:

	Last	Change
S&P futures	3138	3.25
Oil (WTI)	58.87	-0.14
10 year government bond yield		1.82%
30 year fixed rate mortgage		3.98%

Stocks are up as we head into the FOMC meeting. Bonds and MBS are flat.

The FOMC will meet today and tomorrow, with the interest rate announcement expected Wednesday at 2:00 pm. The Fed Funds futures are predicting no change in rates. That doesn’t necessarily mean the markets will ignore what is going on, as subtle changes in language can have out-sized effects on the markets. One such word is “symmetric.” The word symmetric refers to the Fed’s 2% inflation target, and how much they will tolerate inflation above that target. The Fed desperately wants to avoid the low inflation / low growth trap that evolved in Europe and Japan, and is signalling to the markets that they will allow inflation to run above 2% for an extended period of time.

The Fed will also be watching the overnight repurchase market, to ensure we don’t have another situation like late September where overnight rates spiked over 10%. This was due to a shortage of cash in the market. While this sort of thing doesn’t affect mortgage lending directly, it does raise the cost of borrowing for MBS investors, which can cause them to sell these securities to raise cash. That flows through to rate sheets. While the shortage caught the Fed flat-footed in September, they have been discussing the issue, so hopefully we don’t see another replay at the end of this month.

Fannie and Freddie are tightening the restrictions for their Home Ready and Home Possible programs. Previously, borrowers with incomes at the Area Median Income (AMI) were qualified for these 3% down programs; now they will be limited to borrowers at 80% of the AMI. This is all part of the strategy to reduce Fan and Fred’s overall risk prior to setting them free. Note that they are currently interviewing banks to handle the IPO, which will be somewhere between $150 billion and $200 billion. This would dwarf the record for the largest IPOs in history – Saudi Aramco and Alibaba – by over 6x.

Despite a glut of McMansions in some areas, Toll Brothers beat estimates and forecasted a strong 2020. The company noted demand increased throughout the year, and the recent weeks have been stronger than the prior quarter, which is encouraging given that typically you see a slowdown this time of year. Douglas C. Yearley, Jr., Toll Brothers’ chairman and chief executive officer, stated: “Fiscal 2019 ended on a strong note. Building on steady improvement in buyer demand throughout the year, our fourth quarter contracts were up 18% in units and 12% in dollars, and our contracts per-community were up 10% compared to one year ago. Through the first six weeks of fiscal 2020’s first quarter, we have seen even stronger demand than the order growth of fiscal 2019’s fourth quarter. This market improvement should positively impact gross margins over the course of fiscal 2020.”

Small business optimism grew in November, according to the NFIB. Recession worries faded into the background, and impeachment remains little more than a curious albeit boring sideshow, similar to the Clinton impeachment saga which had zero effect on the markets. Improving labor conditions were a big driver, with 26% of firms planning on raising compensation in the coming months – the highest in 30 years. (BTW, this is music to the Fed’s ears). It looks like the drag from the 2017-2018 rate hikes are behind us, and the headwind has turned into a tailwind courtesy of the recent rate cuts.

Productivity declined in the third quarter as output increased 2.3% and hours worked increased 2.5%. Unit labor costs increased by 2.5%.

Morning Report: Quiet week ahead

Vital Statistics:

	Last	Change
S&P futures	3120	7.25
Oil (WTI)	57.79	0.24
10 year government bond yield		1.78%
30 year fixed rate mortgage		3.93%

Stocks are higher this morning after China agreed to take more steps to protect US intellectual property. Bonds and MBS are flat.

The upcoming week should be relatively quiet with the Thanksgiving holiday. SIFMA is recommending early closings for Wednesday and Friday. Wednesday will have some important economic data with GDP and personal incomes, but with the Fed on hold, economic data is going to take a backseat. Note Jerome Powell is expected to give a speech tonight after the market close.

The CFPB is taking a look at loan originator compensation, and is thinking about relaxing some of the rigid rules regarding variations in compensation. The biggest issue surrounds state loan programs, which are meant to make a mortgage more affordable and help get people into homes. Most of these programs have strict limits on how much the originator is permitted to make on a loan, and is often well below what the lender will make on normal conforming loans. This rule change will allow loan officers to lower their compensation to make these programs work financially for the lender. The Bureau is also looking at allowing lenders to decrease LO comp on loans where there are errors due to LO mistakes.

The investment community (firms like Blackrock, PIMCO, and Fidelity) are encouraging the Trump Administration to include an explicit government guarantee for Fannie and Freddie loans in its housing reform. The Trump Administration’s plan to privatize the GSEs does not contemplate an explicit government guarantee – and they would like to reduce the size of the government’s footprint in the mortgage market. Note they never had one – the GSEs were “government sponsored” entities, which doesn’t mean “government guaranteed.” Fannie and Fred were always public-private hybrids. Any sort of explicit government guarantee would require legislation, and that is probably going to be almost impossible absent another crisis.

Morning Report: Manufacturing contracts

Vital Statistics:

	Last	Change
S&P futures	2924	-14.25
Oil (WTI)	53.85	0.24
10 year government bond yield		1.64%
30 year fixed rate mortgage		3.89%

Stocks are lower this morning on overseas weakness. Bonds and MBS are up small.

Manufacturing contracted for the second month in a row, according to the ISM Manufacturing Survey. New orders, production, and employment all fell. Some of this is due to the trade wars, however overseas economic weakness is probably the dominant driver. Historically, this number on the ISM would correlate with GDP growth of 1.5%. In other words, the number isn’t signalling a recession, but it is pointing to a slowdown.

Mortgage Applications increased 8.1% last week as purchases increased 1% and refis increased 14%. “Mortgage rates mostly decreased last week, with the 30-year fixed rate dropping below 4 percent for the sixth time in the past nine weeks. Borrowers responded to these lower rates, leading to a 14 percent increase in refinance applications,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Although refinance activity slowed in September compared to August, the months together were the strongest since October 2016. The slight changes in rates are still causing large swings in refinance volume, and we expect this sensitivity to persist.”

Despite the issues in the manufacturing sector, Freddie Mac expects housing to to remain strong. Overall, government spending and business investment are probably going to decelerate, but this will be offset by a strong labor market and robust consumer spending. Note the uptick in originations. Freddie was initially anticipating this year would be more like $1.6 trillion.

Freddie is forecasting 1.9% GDP growth in Q3 and 1.8% in Q4. What is the risk to these numbers? To the downside, slowing global growth and perhaps political uncertainty – though the markets seem pretty blase about the impeachment drama. To the upside? Homebuilding. Note the strength in the homebuilder ETF (XHB), which has been on a tear. We are approaching the bubble highs, and as the Millennial Generation begins to start families and head to the suburbs, the builders will be busy addressing the dire shortage of starter homes. The post-bubble “new normal” of 1.3 million housing starts a year is anything but normal and we probably need 2 million just to satisfy pent-up and incremental demand.

ADP reported 135,000 jobs were created in September, which matches the estimate for Friday’s jobs report. Construction reported an increase, while mining and natural resources declined. The service sector continued to add jobs as well.

Morning Report: Fannie and Freddie are told to level the playing field.

Vital Statistics:

	Last	Change
S&P futures	3005	7.25
Oil (WTI)	57.95	-0.64
10 year government bond yield		1.69%
30 year fixed rate mortgage		3.96%

Stocks are higher this morning after China made some agricultural trade concessions to the US. Bonds and MBS are flat.

House prices rose 0.4% MOM and 5% YOY in July, according to the FHFA House Price Index. Home price appreciation has slowed across the board compared to 2018’s numbers. This is despite a meaningful drop in rates. Separately, the Case-Shiller index was more or less flat on a MOM basis and up a couple of percent annually.

One of the best predictors of rising wages is the quits rate, which has been inching up slowly since the economy bottomed out in 2009. The latest reading had it at 2.6%. We are seeing an uptick in the quits rate for the bottom income brackets, with 12% of all lower income households switching jobs during the spring and early summer. For all the concern about income inequality, this is a welcome sign. Separately, another 1.3 million workers will qualify for overtime pay due to a new Labor Department directive.

The FHFA has issued a directive to Fannie Mae and Freddie Mac to end guarantee fee discounts for high volume lenders. “We trying to make sure Fannie and Freddie aren’t driving consolidation in the market, but instead they’re providing a level playing field, and that’s really something we’re focused on,” Calabria said Monday at a National Association of Federally Insured Credit Unions conference. “One of the things that really concerned me before the crisis was that it wasn’t unusual where the big guys like Countrywide would come in and they pay G-fees down here and you come in and pay G-fees up here.” The ruling would level the playing field for smaller lenders, and apply the principle of “same rate of return for the same risks, regardless of size.”

What will be the implications of this change? Until we have a better grasp of how Fannie will make changes, it is hard to tell. It will probably push the redevelopment of the private label securities market. If other insurers can compete for the big aggregators, then we might see a more competitive marketplace, and will reduce the taxpayer’s footprint in the mortgage market.

Morning Report: Home price appreciation is decelerating

Vital Statistics:

	Last	Change
S&P futures	2896	12.5
Oil (WTI)	54.15	0.54
10 year government bond yield		1.52%
30 year fixed rate mortgage		3.82%

Stocks are up this morning on no real news. Bonds and MBS are flat.

Home prices rose 3% YOY and were flat MOM according to the Case-Shiller Home Price Index. “The southwest (Phoenix and Las Vegas) remains the regional leader in home price gains, followed by the southeast (Tampa and Charlotte). With three of the bottom five cities (Seattle, San Francisco, and San Diego), much of the west coast is challenged to sustain YOY gains. For the second month in a row, however, only Seattle experienced outright decline with YOY price change of -1.3%. The U.S. National Home Price NSA Index YOY price change in June 2019 of 3.1% is exactly half of what it was in June 2018. While housing has clearly cooled off from 2018, home price gains in most cities remain positive in low single digits. Therefore, it is likely that current rates of change will generally be sustained barring an economic downturn.”

Meanwhile, houses with conforming loans rose 5% on a YOY basis, according to the FHFA House Price Index. The previously hot markets on the West Coast are cooling, although if you focus on homes at the lower price points, they are still up YOY. Note that many of these indices are looking at data that is a couple of months old. Prices aren’t yet taking into account the big recent drop in rates.

The Trump Administration is set to release its plan on dealing with Fannie and Fred just after Labor Day. The government is eager to shrink its involvement in the mortgage industry and the concern is that asking the GSEs to hold bank-like capital levels will raise costs for homebuyers. The government is likely to reduce the GSE’s footprint by limiting the types of loans they can purchase – especially second homes and cash-out refinances. Another issue is the explicit government guarantee for MBS issued by Fannie and Fred, which will require Congressional involvement. “The report is likely going to have a lot of language about embracing congressional reform and reducing the GSE footprint, which most market participants support. But if the real intent is to end conservatorship administratively, then the MBS market will react very negatively,” said Michael Bright, chief executive of the Structured Finance Association. What that means is that if the Administration privatizes the GSEs without maintaining the government backstop, then MBS prices will fall, and that will raise mortgage rates at the margin.

Morning Report: Existing Home Sales rise

Vital Statistics:

	Last	Change
S&P futures	2955	4.5
Oil (WTI)	57.79	0.24
10 year government bond yield		2.03%
30 year fixed rate mortgage		4.01%

Stocks are higher this morning on no real news. Bonds and MBS are flat.

Business sentiment in Germany hit a 5 year low, which is pushing Bund yields lower. The US Treasury market is being pulled by overseas weakness, but many are trying to interpret the US yield curve’s flattening as a recessionary indicator. Don’t buy it. Rates will probably meander lower unless we get indications of persistent 2%+ inflation. Separately, Trump tweeted that the Fed doesn’t know what it is doing, though he denied considering demoting Jerome Powell.

We have a lot of housing data this week, with the Case-Shiller and the FHFA Home Price indices. We will also get new home sales. The only potential market mover is personal income / personal spending on Friday. The third revision of first quarter GDP will be released on Thursday.

Existing home sales rose 2.5% in May, according to NAR. Total Sales came in at 5.34 million, a drop of 1% on a YOY basis. The median home price rose to $277,700 from $265,100 a year ago. Falling mortgage rates are helping home sales as the 30 year fixed rate mortgage flirts with the 4% level again. Inventory is still tight however, at only a 4.3 month supply.

Economic activity picked up in May, according to the Chicago Fed National Activity Index. Production-related indicators led the increase, which jumped from -.48 to -.05. This means the economy is more or less growing on trend after a weak April. The CFNAI is a meta-index of 85 economic indicators, so it really is a lagging index. It isn’t a market-mover.

Signs of life in the private label securitization market? Cerberus (a large private equity firm) did the first post-crisis HELOC securitization last week. HELOC securitization was only done during the bubble years, and many of these loans turned sour in the housing bust. Cerberus only issued the most senior AAA tranche, and it priced at L+105, a bit worse than the initial price talk. Cerberus did not sell any of the junior pieces.

Ginnie Mae has let Loan Depot out of the penalty box. Ginnie Mae has been focused on prepayment speeds for VA loans, which is an indication that a lender is churning VA loans through the IRRRL process. “The removal of such a restriction is based on the Issuer having demonstrated to Ginnie Mae’s satisfaction that (a) its prepayment speeds are substantially in-line with those of equivalent multi-Issuer cohorts, and (b) such improved performance is sustainable,” the agency said in a statement.

Freddie Mac is rolling out a new rehab loan: the CHOICERenovation loan. It will allow the buyers to roll the renovation costs into the loan, permit them to begin renovations after they move in, and the homeowner can act as his own contractor. “There’s a fair amount of housing with deferred maintenance,” Danny Gardner [Senior VP of single-family affordable lending at Freddie Mac] said in an interview. Cash-strapped buyers “should be very willing to undertake those issues if they can get houses at an affordable price.” The program is not available quite yet, but it should be out sometime this summer.

Contrary to expectations, professional investors are still buying starter homes and renting them out. Investors purchased 20% of the houses in the bottom third of the national price range in 2018, which is 5% more than the historical average. Many expected the REO-to-Rental trade to fizzle out as investors would ring the register. So far, that hasn’t happened, as home construction remains firmly mired in recessionary territory.

Morning Report: Wages and interest rates

Vital Statistics:

	Last	Change
S&P futures	2851	-35
Oil (WTI)	62.46	0.8
10 year government bond yield		2.43%
30 year fixed rate mortgage		4.15%

Stocks are lower this morning after rhetoric between the US and China hardened over the weekend. Bonds and MBS are up.

The rhetoric over trade intensified over the weekend, with both China and the US blaming each other for the impasse. As promised, the US hiked tariffs on $200 billion worth of Chinese goods on Friday and blamed China for reneging on its deal. In response, China said it would never surrender, and has raised tariffs on about $60 billion worth of US goods starting on June 1. FWIW, the issue with China is not so much tariff-related, it is intellectual property related.

This week is relatively data-light, at least as far as market-moving data is concerned. We will get housing starts and the NAHB Housing Market Index, along with a lot of Fed-speak.

Uber priced its IPO on Friday at $45 a share, and the stock ended up opening at $42. It never broke above the IPO price for the entire day. The record for IPOs has been downright awful and they have gone from being an almost sure thing to a greatest fool tournament. Historically, bankers would underprice IPOs by about 10% – 20%, so that investors would get a nice bump on the first day. Of course this means the company left some money on the table, but everyone was generally happy with that arrangement. Today, all the value is extracted in the pre-IPO funding rounds, so by the time it hits the public stock exchanges the companies are fully valued (if not overvalued). I have to imagine the big institutional investors are going to start turning these things down.

The share of 43%+ DTI loans going to Fannie and Freddie has almost doubled over the past couple of years from 15% to 30%. This is triggering more debate over the “QM patch” that allows safe harbor for loans with DTIs over 43% as long as they are GSE loans. This provision is slated to expire in 2021, but affordable housing advocates are pushing for it to be extended. Interestingly, the Urban Institute says that while default rates for 45+ DTI loans were higher prior to the crisis, that is no longer the case. Urban Institute has an agenda to push, so counterintuitive findings like that might be the result of some statistical jiggery-pokery and further examination is warranted.

Neel Kashkari is making the argument that rates should stay low due to income inequality. This is not necessarily a new argument – Janet Yellen said she was willing to let the labor market “run hot” for a while to wring all of the slack out of the labor market. Historically, the Fed has shied away from political footballs like income inequality, fiscal policy, etc given the fact that the Fed handles banking regulation and the Fed Funds rate – tools that aren’t suited to tackle either issue. In fact, you could make the argument that loose monetary policy increases inequality due to the fact that it pushes up asset prices. Here is another issue: if low rates increase the cost of shelter more than it helps increase wages, it could in fact be a negative for those that rent. Note that he isn’t arguing that the Fed should cut rates, but he is in favor of waiting to see if inflation returns.

That said, wage growth has been strong over the past couple of years as the labor market has strengthened. If you compare the yield on the 10 year bond to wage growth, historically they have correlated reasonably well. Over the past couple of years, the 10 year yield has fallen while average hourly earnings have increased. Given that labor’s share of GDP is still around historical lows, wages have to rise further to reach historical averages.

Morning Report: Small mortgage origination has fallen

Vital Statistics:

	Last	Change
S&P futures	2867	-17
Oil (WTI)	61.91	-0.21
10 year government bond yield		2.45%
30 year fixed rate mortgage		4.17%

Stocks are lower as the trade-driven sell off continues. Bonds and MBS are up. Note Jerome Powell will be speaking around lunch time. Also, the long-awaited Uber IPO will price after the bell.

Inflation at the wholesale level increased 0.2% MOM and 2.2% YOY in April according to the Producer Price Index. Ex-food and energy, they rose 0.1% / 2.4%. We will get the consumer price index tomorrow.

Initial Jobless Claims came in at 228k last week.

FHFA Chairman Mark Calabria said that Fannie and Freddie may be released from conservatorship even if Congress doesn’t accomplish housing reform. He also signalled that Congress would have an “entire Congress” – i.e. at least 2 years to hash out a solution. Calabria has not said that he would end the “net worth sweep” which sends all of the GSE profits to Treasury, which has created capital shortages for the GSEs.

Fewer and fewer mortgages are being made in the lower price tiers, which is having an impact on entry-level borrowers. The article blames lender focus on the jumbo space, but that probably isn’t really the driver. They look at the number of low balance mortgages (10k – 90k) being originated today versus 10 years ago. It turns out that the number of small loans is definitely lower. I think there are a few factors going on here: First, 2009 was the beginning of the big wash-out in real estate prices and the number of homes in that price range was a lot higher in 2009 than it is today. In other words, home price appreciation is the biggest driver. Second, compliance costs are simply much higher, and as the MBA has demonstrated, costs to originate have been rising relentlessly. FWIW, there is demand for low balance mortgages – the prepay speeds are much lower so investors are willing to pay up for them – but that probably doesn’t offset higher costs. Finally, it is hard to get loan officers excited about an 80k mortgage when they are only making 75 basis points on it to begin with. Given that an 80k mortgage requires as much effort as a 800k mortgage, it makes sense for loan officers to focus on larger loan balances.