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Mortgage applications fall off a cliff, REIT opportunities ahead

Brent Nyitray, CFA, MBA

Realist mortgage applications review, September 2–6 (Part 2 of 5)

(Continued from Part 1)

Mortgage applications fall off a cliff on a short week

The MBA Applications index fell 13.5% on a short week due to the Labor Day holiday. Refinances drove the decline with a 20% drop in the index. Purchase activity fell slightly.

All about the jobs report and its effect on quantitative easing

Last week was all about Friday’s jobs report. Basically, the report was disappointing, with the drop in the headline unemployment rate the only positive element. Since the drop in unemployment was due to the lowest labor force participation rate since the days of disco, you should at least put an asterisk by it. The jobs report was neither good enough nor bad enough to change the Fed’s intended policy—so expect some reduction in asset purchases to be announced at the September FOMC (Federal Open Market Committee) meeting, or at the very latest, the December FOMC meeting.

Big opportunities ahead for mortgage REITs that focus on origination

The mortgage market is undergoing a massive transformation as the private label mortgage market returns. Bob Corker (R-TN) and Mark Warner (D-VA) recently introduced a bill to end GSEs (government-sponsored enterprises) and put the government in a re-insurance role. All the securitization that was done by Fannie Mae and Freddie Mac will now be done by private entities, some of whom could be mortgage REITs. Yesterday, President Obama laid out his plan for the future of mortgage origination, and it looked very similar to the Corker Warner bill.

Since the bubble burst, mortgage origination has been almost exclusively government-driven. The big buyers of new origination have been the agency REITs like Annaly (NLY) and American Capital (AGNC). The U.S. government bears 50% of the credit risk of the entire U.S. mortgage market. Originators typically don’t hold their mortgages: they either sell them to the big banks or securitize them. Since the securitization market has been dead, originators have no outlet for non-agency mortgages. Redwood Trust (RWT) has been the only issuer of private-label mortgage-backed securities (securities backed by mortgages that aren’t government-guaranteed), and it has focused exclusively on high-quality jumbo loans. Pennymac (PMT) noted on its call that origination increased nicely in the second quarter.

In the beginning of the year, we saw a wave of private label deals, but subsequently, spreads have widened and the deal flow has slowed. The recent back-up in rates has basically put a freeze on the private label market. At some point, the back-up has to affect jumbo pricing. The vast majority of the deals were extremely high-quality loans with significant over-collateralization, so they look nothing like the private label deals done at the end of the bubble. The sense is that more deal flow will happen once the government settles on how it wants to regulate private-label securitizations. Finally, increases in origination will help servicers like Nationstar (NSM) and Ocwen (OCN).

Continue to Part 3

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