Mortgage

October 21, 2014 By howardpr Leave a Comment

The Power of Fear

I’ve written a few articles about the power of economic indicators and interest rates, and how both affect financing properties and leverage. The jobs report, consumer confidence, the pending sales index, and housing starts are just a few examples of these indicators. For the longest time, they were bellwethers for the industry. However, I would like to submit a new power broker to the list as the most significant mover of the interest rate market, and it’s called fear.

Economic fear has been pervasive throughout this entire recession. Americans don’t feel secure about their jobs, earnings, their housing situation, or the country’s future. Accordingly, this fear has manifested into rates that haven’t been this low since polio was eradicated in the United States. This fear is legitimate–it gets to the psyche because it’s real. People are feeling it in their pocketbooks. Homes are lost in foreclosure. Coupons are clipped and used in the grocery store. These actions create anxiety that causes people to pull back on purchases, walk away from homes, and work longer hours without complaining. However, the fear that I’m referring to has nothing to do with economics.

During the week of October 13^th 2014, it was all about Ebola. Sure, the news was awash with reports about a second recession in the Eurozone, and the market reacted in the appropriate way. Rates dropped by one-eighth of a percent. However, when the announcement was made that a second nurse contracted Ebola from the Dallas area, the media went wild and rates cratered. Understandably, news reporters discussed other “bad news” in the world. Bomb strikes in Syria failed to have the intended effect of getting ISIS out of Kobani, but it was the Frontier flight from Cleveland that captured people’s attention. Subsequently, as the details of the flight and passengers were released, fear started to set in and interest rates plummeted.

Americans have grown to become numb to negative economic news. We had more beheadings, GDP figures out of Germany and Italy weren’t hitting the mark. More new homes are sitting vacant in more markets for more days. Retail sales are much lower than expectations for the year (and this time we can’t blame it on the snowy weather). In many cases, these market movers were announced around the same time back-to-back. Amazingly, we barely got a nudge in rates. The average rate on a fixed 30-year was 4.25%, and maybe with two or three pieces of bad news we could find ourselves temporarily at 4.125%…..or even 4.00%. Unfortunately, it is usually short-lived, as some consumer confidence figure or unemployment report is positive for the month and rates jump back up to 4.25%. However, not this time–we have a new fear to contend with.

The fear created by the Ebola scare is different. The government can’t manipulate or make it better with spin control. The best and brightest public health doctors have been unable to contain it. It kills in a vicious way and it can be sitting right next to you on your way home. The news reports paint a grim picture of the virus. The images of individuals lying flat on their backs in protective bubble transport canisters are eye-popping. The grim images of field workers carrying bodies away to be burned are awe striking. Fear is setting in that the virus may come to a town near you. As gruesome and fatal as Ebola is, this level of fear is great for rates. The market has been pushing to get below 4.125% for the longest time. Now, the flirtation is over. Rates have returned to the high 3s. A new surge in applications arose this week and this can be attributed to good ole fashioned fear. Borrowers are letting their rates float, because the pandemic could get worse and their rate could get better. As bizarre and morbid this may sound, poor conditions and literal death in the streets is yielding lower rates for borrowers.

Therefore, some people in the industry, both borrowers and players alike will temporarily profit from a strong surge in business due to the fear of Ebola. Whether the disease flies or walks in, the fact that it can be concealed until the truth is obvious will keep folks guessing and scared. Where there is fear, there is uncertainty. Where there is uncertainty, there is a flock to safety, which usually means treasuries. And when treasury rates go down, mortgage rates commensurately respond in-kind thereafter.

Typically, the bad news that drives interest rates lower is temporary. Confidence goes down, but eventually comes back up. Sales go down, but bounce back as well. Ebola is a new thing. Some people are losing their lives, while others are losing their minds out of pure fear. I know that bad news is good for business, but this type of fear carries permanent consequences. Personally, I don’t think that our mortgage market should ever celebrate a rally based on mortality; however, there are others who may say that I am completely wrong!

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance; he can be reached at howardpr@rosecityrealtyinc.flywheelsites.com.

October 17, 2014 By howardpr Leave a Comment

Who Wants My JUMBO Loan?

If you speak with almost any residential mortgage broker, they are aiming for two numbers: $417,000 and $625,500. These two numbers represent the upper limit caps for loan sizes that Fannie Mae and Freddie Mac have determined to be “eligible” and “acceptable” for “conforming, high balance conforming, and agency financing.” Once you reach the higher limit, you venture into another domain known as “non-conforming” or JUMBO financing. Given that 90% of all mortgages are now squeezed into conforming parameters, JUMBO loans, though lucrative for their size and commensurate commissions, are harder to close than conforming ones. In many cases, jumbo loans are harder to sell for the banks that originate them. Therefore, how should a borrower and their banking partner respond to this scenario? Let’s consider what is currently occurring in the marketplace.

By and large, most banks “churn and burn” mortgage paper, which means that they originate loans to earn income from the spread and associated fees, throw them into a pool of mortgages of similar characteristics, package them with an investment bank, and then sell to investors as mortgage backed securities. This process is similar to any other stock or bond. However, the paradigm has quickly shifted. In the past, nearly half of all JUMBOs were originated, sliced, diced, and sold to the investing public. Now, in the first half of 2014, not even 5% of JUMBOs were securitized. Amazingly, banks are starting to “hold their paper.”

With a cost of capital priced below 1%, banks are making a nice sized spread on loans that are relatively low risk. The math is easy–they charge 4.25% interest on the loan and pay .85% interest (if that), on an interest bearing checking account. They keep the 3.4% difference. Moreover, they are mining the loan applications of borrowers and cross selling services. One may ask– why securitize and just sell off, when you can hold and cross sell products such as checking accounts, money management services, controlled disbursements, credit cards, lines of credit, foreign exchange, and any other service that a banking institution could offer a client, particularly a wealthy one.

If banks aren’t squeezing loans to fit the Fannie/Freddie model, they are reviewing their own credit policy, which for the right borrower or situation can be quite flexible; especially if the chief credit officer has the authority to show latitudinal discretion on loans placed in the bank’s portfolio. But, the bank’s size does matter. All of the banks are getting into the “hold the JUMBO” game. Wells Fargo, BofA, and US Bank, are all in the process of increasing their private client services/wealth management divisions, and the JUMBO is a great way to mine for new prospects at a low cost. If the loan officer creates goodwill along the way, the transition into more products for the bank could be huge.

Regional and local players are jumping into the game as well. They may not have the capacity to offer large-scale private client services as many of the money center banks, but regional and local players have stepped up their game with regards to expanding services offered to business owners. Many regional and local banks have very effective small business departments and are more nimble (and preferred) for servicing the needs of an entrepreneur. With a JUMBO as a lead in, the product mix with a smaller bank will expand to lockbox, letters of credit, and other cash management, but with a small town touch, local flair and an expertise that a larger institution may not be able or wanting to provide. With that, you can see why even if the securitization market is not crying for JUMBO mortgages, there are others who are salivating to get a loan such as these on the books and aim for auxiliary sales.

So if you don’t fit within Fannie or Freddie’s black box of guidelines, don’t worry–you have options. Strong borrowers with good credit and great assets are valuable commodities to other institutions that aren’t looking for a “one-off” transaction, but instead are looking for a long-term relationship. It goes without saying that the JUMBO market is huge. The loan sizes are huge, as well as the incomes of the borrowers, but nowadays, so too are the alternatives available for closing the loan and servicing the borrower thereafter.

September 30, 2014 By howardpr Leave a Comment

Interest Rate Uncertainty

Every time that I hear that the nation’s Federal Reserve Board of Governors will get together, I get nervous (along with at least 1 million other folks who are interested in what these policy wonks have to say). In the latest rendition of Federal Reserve folly and fodder, a lot of predictables came to the forefront. The confirmation of the windup of Quantitative Easing III (QE-III) was confirmed. Thus, the last month of Fed purchases mortgage backed and treasury securities will occur in the month of October, and the artificial market for fixed income products will cease to exist. Also on the Fed’s agenda are the accelerated plans to increase short-term rates. Many people expect short-term rates to jump up by .25%, others 50%, and many a full 1.00% (though that is highly doubtful). In all cases, the Federal Reserve Bank’s meetings have become more difficult to decipher, as vagueness and collegiality are now the rules of the day, which go hand-in-hand. Unfortunately, the governor’s desires to appear respectful to one other, while being cryptic to the public have resulted in undesirable effects.

Clearly, markets are making their own decisions about what will happen. Currently, two-year short-term treasury rates are hovering in the .6% range. The average rate for 10-year securities is 2.6%. For those of you who may not follow rates this closely, these are some of the tightest spreads in history. Many feel that this is due to the uncertainty coming from the Fed that is creating uncomfortable waves in our general economy; particularly with regards to an increased number of people who are now employed, but experiencing an average decrease in the dollar amount of wages earned, when adjusted for inflation as reported by the Labor Department. Job losses have slowed and in many cases have been added back to the economy, but people are earning less overall.

Economic indicators are on a seesaw. The months of May and June 2014 revealed decreases in housing construction. The Census Bureau reported that July 2014 reflected a new record of construction jobs, as over one million housing permits were issued. Unfortunately, August construction figures fell off of an economic cliff, as permits issued decreased by almost 15%. Additionally, builders aren’t building homes like they used to, as 10% of vacant homes across the nation, are the ones that were just built! Builders are shifting their attention to multi-family apartment buildings, as there is a broad belief that more consumers are going to be renters as opposed to homeowners in the years to come, as their financial profiles will be weaker than before. We are living in an economic state where more people are employed at lower wages, more derogatory information credit reports, and a general reduction in available credit to make real estate purchases a reality.

The pending shutoff of the most effective stimulus in the history of the American economy, coupled with consumer tepidness unseen since the great depression is a conundrum for the Fed. An increase in rates is needed. With an unstable world around us, Americans want to pull their investment dollars back stateside. Beheadings, border skirmishes, threats of Scottish cessation, and the dismantlement of parliaments in almost every country have left American investors weary of investing abroad. Accordingly, one of the main reasons why rates must increase is to entice these dollars to come back home. However, the will and the economic bravery to do so are unknown.

As people from Main Street, Wall Street, and academia fret and wonder when Janet Yellen and Co. will make some tough but necessary decisions, the uncertainty surrounding not only interest rates, but our economy may not be the main topics of conversation around the lunch counter or our dinner tables, but their consequences will. Unemployed investment bankers will want to have a clue about next steps. Former mid-managers working in entry-level sales positions will want to get some clarity of the future. Also, students in academia considering a college education will watch with trepidation, as many won’t see the benefit of going to college, Med or Law schools if they will be mired in debt with no jobs paying sufficient wages to allow them to live.

Indeed, just thinking about the economy and the effects of raising rates is quite depressing. I hope that the Fed and its contemporaries around the world can figure out when to pull the interest rate trigger. It is said that knowing is half the battle. I guess that not knowing won’t even arm you to be in the battle, and that’s a scary proposition. To the members of the Federal Reserve Bank, we the American people want to be armed and ready, so please speak up soon!

September 15, 2014 By howardpr Leave a Comment

When Jobs Don’t Make a Difference

The first Friday of September 2014 was a weird one. The usual Bureau of Labor Statistics jobs report that was to be, in fact was not. There was much anticipation and expectation for another month of unbelievable job gains. The entire summer had been filled with employment gains of 200,000+ per month. In the end, although the smartest forecasters predicted a final tally of 225,000 net new jobs for the month of August, the end result was a paltry 142,000 jobs; the lowest monthly tally of the year. What was even more amazing was that the final figures for jobs in June were revised downward for a loss of 31,000 positions. The net effect was that mortgage rates dropped, as safety and security concerns became the buzzwords of the day. However, this wasn’t the final effect.

As the day continued, the bond markets weakened and the nation’s banks adjusted their rates upwards, over and over, inch-by-inch. By the afternoon, all of the gains that the horrible jobs report cited were erased, as rates that flirted with 3.875% were back up to 4.125%. The momentary break in the action that brought terror to the economy, but delight to borrowers and mortgage professionals was gone.

The week had been an amazing one for the history books. Rates increased higher and higher as speculation grew for a jobs report that was going to yield the highest job growth of the summer. Unfortunately, it was not to be. In fact, a double whammy occurred. Domestically, the jobs report was dismal. Internationally, the European Central Bank (ECB) capitulated and decided to follow the Federal Reserve Bank’s lead by instituting a bond purchase program, along the order of QEI, II, and III. With an exasperating jobs report and the announcement of the ECB purchase program, rates should have solidly broken through the 4.00% floor; but uncharacteristically, it was not to be.

This type of market behavior is completely out of form. It runs counter to academic textbooks, mortgage theory and common sense. Normally, as the markets show economic weakness, investors of all sorts flood into safe investments; namely, treasuries and mortgage backed securities; commensurately, interest rates fall. So why not in this instance? We have global turmoil in the form of beheadings in the Middle East, unprecedented corporate losses in Germany, and brand name Italian clothiers financially strapped. At home, fewer people are getting full time jobs, pessimism is still grabbing a hold of the majority of people’s sentiments, and the unemployment rate is only falling because more people are giving up the search. We would completely expect rates to fall, right? At other times in the past, the mere mention of a bad jobs report could send rates down 0.5% – 1.00%, but not this time. The reverse occurred. Why?

It could very well be that investors of all sorts around the world are ignoring the data. The underlying belief could be that the recent economic anemia was just a blip or an economic bump in the road. Historically, August jobs data is revised upward by approximately 100,000 jobs. It could be that financial historians believe that the same will occur this year, and that we should wait for the final adjusted figure to be revealed. Other speculation is that the market is no longer convinced that a weak job report is still the best measuring stick for the true state of employment in the United States.

Thus, where does that leave us in the prognostication of interest rates? What reliable piece of data can we use? If dismal job growth, global instability, consumer depression along with price deflation won’t do it, what will? Clearly, we are living in a time of caution. Given the unprecedented events that have followed the Great Depression, I conclude that there is no one magic or silver bullet that can be used to predict which way interest rates are going to go, as the ones that we relied on in the past don’t work anymore. However, I believe that once the world’s economies begin growing without Central Bank assistance, then we will know what the new economic levers will be that will move and shake the markets. Until then, we will be guessing, because to a large extent, the market’s movements are artificially generated and manipulated by Central Bank monetary stimulus and large institutional investors as opposed to good ole’ fashioned economic “big” data.

As has been said since the printing of Guinness’ first volume back in 1955, when speaking of the lack of movement in this interest rate marketplace, this is truly one for the record books!

September 6, 2014 By howardpr Leave a Comment

Are We Ready for Inflation?

Everyone has talked about it. All of the intellectuals in the economic and financial community know that we desperately need it. Even people on Main Street understand that we need it, once they comprehend its effects on their paycheck. The “it” is obviously inflation, or as Webster’s would put it, the continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.

As much as the “rise in the general price level” sounds like sin to a person who just paid $4.25 for a gallon of gas, when they only paid $3.85 for the same gallon just three weeks ago at the same pump, the need for inflation is evident. Wages are stagnant like pond water and pay raises still sound a foreign language to most workers, accordingly, they are living on less, as prices of other goods and services march onward and upward. The idea of “inflated income” sounds wonderful to a worker living on minimum wages, a long overdue sign of appreciation to a middle manager or a taste of the holy grail for a top level manager. So depending on how one looks at it, inflation can be a very good thing.

Commensurately, interest rates normally rise with inflation. This has been the talk of the financial papers for all of 2014, and the bane of Janet Yellen’s existence since she became the Fed Chairwoman. “When is the Fed going to raise rates?” “Is the Fed going to get ahead of inflation or will they time it wrong?” “Has the Fed waited to late to put the brakes on the economy?” These are all fair questions to be asked because runaway prices can wreak havoc on an economy. If one thinks back to the late 70s/early 80s, memories of 17% mortgages and the sky-high prices for a “basket of goods” still runs deep in the mind. In those times, a near 20% interest rate combined with a strict debt to income or unbendable debt service coverage ratio requirement made qualifying for a real estate loan nearly impossible, as the high interest rates choked off affordability. However, with rates so low, a new phenomenon is occurring; prices of real estate assets have jumped so atmospherically high that returns are in the low single digits. This barely covers taxes, let alone inflation!

The one thing that inflation and higher interest rates did do during this time period was usher in an era of decent asset prices. If one could afford the payments, or if one could find a way to acquire properties with a seller carry back or some other form of creative financing, they could lock in on a property tax level that didn’t rival the payment of two BMWs. I admit higher interest rates are not fun, and the rates of today are the lowest in over 60 years, however, the purchase price of a property (and its commiserate tax level) is permanent, but its financing rate is not forever. Here in California, during the late 90s, rates were in the high 8s/low 9s. Homes in Redondo Beach sold in the $300,000s. Similar homes in similar areas now sell in the $900,000s with corresponding interest rates in the high low 4s. Which would you prefer, buying a home in the 300,000s at a temporary rate of 9% or buying a home at permanent price tag $900,000 with a temporary rate of 4%? As tempting as that 4% rate appears, the average homeowner only keeps a mortgage 6 years before they refinance. Accordingly, it makes sense to buy at a lower price as opposed to locking in a low rate, because it is tough to do both.

The drawback of reduced borrowing capacity is real with the advent of inflation. Whether mild or severe, a 1% rise in interest rate can reduce the average borrower’s purchasing power by 10-20%. Which is more than enough to wipe out many an American dream. Conversely, inflation severely tempers real estate prices as other asset types (stocks, bonds, mutual funds, etc.) start to offer more attractive (and more liquid) rates of return. A 6-unit, rent-controlled, multi-family building offering a 3% return on investment will get barely an offer at $1,100,000, but it will start to get looks once its price tag comes down to $500,000 or less.

At the end of the day, as bad as it sounds, we need inflation and higher rates to bring normalcy back to the market, as affordability in many parts of the country is unattainable for the average consumer. At an average rate of 1.5%, CDs and savings accounts are the laughing stocks of the financial industry. No one saves in an investment vehicle that has a rate of return lower than the rate of inflation. When JUMBO CDs begin to offer 5% and savings accounts get back to offering 3.5%, then we will see normal behavior. Then we will finally see workers being paid what they are worth and things will start to make economic sense. Until then artificially low rates in history and deflation will continue to foster fears of uncertainty. As crazy as it sounds, I don’t know about you, but I will trade in my financial uncertainty for a slightly higher and a little bit of inflation rate any time. How about you?

August 26, 2014 By howardpr Leave a Comment

The Effects of Uncertainty

This recession has been the fuel for a whole new breed of academics. Those who have attended business school know all to well that the “case study method” is the bread and butter format for introducing and solidifying business concepts that are to be used by the corporate chieftains of the future. However, I am under the complete belief that the case studies of today are going to become firewood and cast aside for content and material being produced on an on going basis as we live our lives in the here and now. There has never been more monetary manipulation employed and private funding deployed in recorded history. While it makes for great material in the classroom, it is creating massive hysteria for economists and financiers of all stripes who are trying to prognosticate profits, econometric trends, and most pervasive of all, interest rates.

Consider this, if a individual is contemplating the purchase and financing of a piece of real property, the “feeling” that they get about the markets will obviously drive a portion (if not all) of their decision. With that said, the Commerce Department recently reported that home builders broke ground on 101,000 new projects in July; a 16% bump up from the month of June. However, a local paper in Los Angeles will recount that home sales in California fell 10% in July from a year ago and appreciation continues to moderate or decline. Which piece of data do you believe? Factually, both sets of data are true. So what is a buyer/borrower to do and what decision should they make?

In another example of uncertainty, the Dow is on an unprecedented tear, having just cracked the 17,000 level. If we can remember recent history, on March 6, 2009, the Dow was at a terrifying low level of 6,624. Unbelievably, the market has jumped over 10,000 points in little over 5 years. This is utterly unprecedented growth in the history of the index. One would think that with headlines such as these, the nation would be popping corks off of champagne bottles and people would dancing in the streets, but we are not. The average earnings of individuals in the US are still less than 70% of what they were earning at the turn of the century. Bankruptcy, short sales, foreclosures and delinquencies are showing up on more people’s credit reports than ever before at all income levels. Both sets of data are true. Which set should you believe in and base your decisions on? What is a buyer/borrower to do and what course of action should they take?

Dovetailing off of the preceding paragraph, statistically, there are less mortgage loans of all types falling into delinquency or foreclosure than ever before. The Mortgage Bankers Association reported that foreclosure proceedings were only started against 0.4% of all outstanding mortgages. This is down from .45 in March of this year and 1.42% in March of 2009 when the Dow was at its 6,624 low. On the other hand, if one peruses the website of the Federal Reserve’s Economic Data site, they will see that 7.39% of all mortgages booked in a commercial bank’s offices are in some form of delinquency. The historical average delinquency rate for this index is around 3%. Which piece of data do you believe? Factually, both sets of data are true. So what is a buyer/borrower to do and what decision should they make?

It’s easy to see why we are in a funk. I can see clearly why rates haven’t moved more than .25% in either direction in over a year when Ben Bernanke stated that the low rate party was coming to a decisive end back on June 19, 2013. The economic indicators are giving us two opposing pieces of data on similar pieces of information. No wonder there is so much uncertainty. Which piece of information should the American people and the world’s inhabitants believe? Should we trust Yellen or Draghi (the European Central Bank President)? Should we believe in better days or subscribe to doom and gloom? Unfortunately, the data suggests that we could follow either mindset and we could find some piece of econometric data to defend either position!

These are unprecedented times indeed. Where do we go from here if we want certainty? I would imagine one could probably find consistent work writing case studies. There is a ton of fresh material and content out there for consumption.