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Why mortgage applications rose despite a bond market sell-off

Brent Nyitray, CFA, MBA

Mortgage Applications Review, December 2–6 (Part 2 of 4)

(Continued from Part 1)

Mortgage applications rose despite a sharp sell-off in the bond market

The MBA Applications Index rose 1% after falling the week before. Mortgage applications have dropped off a cliff ever since rates began increasing last spring. Both purchases and refinances drove the increase. The summer selling season is winding down, and we’re entering a slow period that will last through the winter months. Last year, refinance activity drove business for mortgage bankers. Now, they’ll have to rely on purchase activity, which tends to be very seasonal.

Does the Fed move in December?

The Federal Open Market Committee voted to maintain its current pace of asset purchases at both the September and October FOMC meetings after warning the market it would begin to taper last spring. The market is now handicapping a 50-50 chance of a small tapering at the December meeting. Certainly last week’s strong economic data gives them an excuse to do so. This will be Ben Bernanke’s last FOMC meeting, and how Janet Yellen will operate is an open question, although most think she is as least as dovish as Bernanke was, perhaps even more.

Survey of the landscape for REITs that focus on origination

The increase in interest rates has hurt earnings for originators. Virtually every originator (and bank that has a large origination business) noted decreased earnings in this sector. The easy money from the 2012 refinance wave has been made, and now the originators are focused most closely on the new regulatory landscape that’s taking shape beginning January 1, most notably the qualifying mortgage rule, but also new rules concerning loan officer compensation et cetera.

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. That said, the impending confirmation of Mel Watt suggests that there will continue to be a very activist government role in the mortgage market. There is also the distinct possibility that HARP (Home Affordable Refinance Program) eligibility dates will be expanded, which means more refinance activity for the originators.

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.

In the beginning of the year, we saw a wave of private label deals, and then a slowdown as rates began to increase. We’re starting to see more deals again, as the market has adjusted to the new interest rate regime. 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). That said, Nationstar and Ocwen missed their earnings estimates and the stocks were hit on the drop in origination in Q3. Servicing has increased in value tremendously ever since rates started rising, with newly originated conforming mortgage servicing rights trading at four times cash flow.

Continue to Part 3

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