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Housing Smoke and Mirrors (16) – “Name That Tune”

Written by , KeySignals.com

In Housing Smoke and Mirrors “Re-tuning the HARP”, several dissonant tones were heard in relation to the condition of the housing market. The discord has been created by the “Taper” talk and the consequent sharp rise in interest rates. As the term structure of interest rates stabilizes, after its sharp upward adjustment, commentators with different axes to grind are making their new projections for the future. The incoming data signals how bad the collateral damage has been in the housing market; and provides clues to existing and new trends.

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The June Existing Home Sales data declined significantly.

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Fannie Mae’s July strategic and investment outlook[i] suggested that rising interest rates would force buyers into the market to lock in borrowing costs. The report however also noted that inventories were rising, which suggests that sellers are also being forced into the market because they see rising interest rates negatively impacting prices in the future.

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Released On 7/24/2013 7:00:00 AM For wk7/19, 2013

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The latest MBA financing data, suggests that buyers have not been forced into the market by the threat of rising financing costs. The recent fall in interest rates, after the big increase, stimulated refinancing but had no impact on purchase loans. Buyers now have understood that they own a call option which has some value. Rising interest rates are clearly weakening house prices and falling interest rates have not hit a level that is affordable; it is therefore more attractive to remain on the side-lines.

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The apartment market tightened in June[ii], which also suggests that more potential buyers decided to become renters as borrowing costs increased and affordability declined.

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The National Association of Realtors reported that house prices are within 7% of their previous highs[iii]. Given that inventory is running at about half of the previous level and the US economy is well off its previous peak, it is fair to conclude that specific technical factors rather than fundamental economic activity are behind the housing performance. Clearly constrained supply is one driver of rising prices; and the other must be Quantitative Easing. The Fed has signalled that QE will continue, even though its pace may be reduced in September; so this should weigh on prices. Demand may also soften going forward. The Campbell/Inside Mortgage Finance Housing Pulse Tracking Survey found that both first time buyers and investors pulled back in June; leaving existing owners as the main driver[iv]. RealtyTrac observed rising Short-Sales and declining investor purchases over the same period[v]. Inventory is clearly rising.

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Existing Home Inventories are building, which clearly reflects a fall in demand; and also possibly greater motivation amongst sellers to get out. The inventory trajectory continues to closely shadow the pattern of 2010 which prompted the Fed’s aggressive QE2 programme. This pattern suggests that the housing market is reaching a critical point at which further intervention from both the Federal Reserve and Federal Government may be needed to give it some more momentum.

[Homes.com] reported that the recovery in the housing market has been losing momentum and even reversing in some cases since May[vi]. Fitch is focusing on delinquency rates as a barometer that will signal early signs of renewed stress. Its latest report suggests improving credit quality amongst borrowers[vii]. According to Fitch, the rate of performing borrowers who rolled into delinquency status decreased in the second quarter. New delinquency roll rates showed stronger performance across all categories (subprime, Alta-A, and prime), with non-agency roll rates hitting their lowest level since early 2007. The jury however is out, quite literally, in the case of delinquencies.

The New York Fed released a paper entitled Distressed Residential Real Estate: Dimensions, Impacts, and Remedies[viii].

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This study found that that house price recovery is slower in Judicial States because the foreclosure process takes longer; creating a bigger distressed overhang of properties. Time spent is delinquency across states is the same, but time in foreclosure varies depending on Judicial versus Non-Judicial status. The “Judicial” jury is still out on the sustained recovery in prices. There seems to be a wave of Judicial foreclosures, which have been slow to progress, now breaking at the same time that interest rate rises have caused further weakness. In Housing Smoke and Mirrors “Re-tuning the HARP”, the New York Fed was observed to be investigating the HARP programme; with a view to changing it to become more inclusive and supportive of those borrowers in distress. This latest report signals that the New York Fed has accumulated more data to support its recommendations. The FHFA has recently reported that HARP refinancing activity fell 26% from April to May. The policy makers are clearly worried that HARP is not delivering results, in its current legal configuration, at the new higher level of interest rates. HARP is broken and needs fixing.

The Treasury has also been examining the delinquency issue in relation to re-default rates amongst borrowers already in the HAMP programme[ix].

HAMP Conditional Re-default Rates Over TimeClick to enlarge

Cumulative Re-Default Rate by Reduction in Monthly Mortgage PaymentClick to enlarge

Cumulative Re-Default Rate by Delinquency at Trial StartClick to enlarge

Cumulative Re-Default Rate by Credit Score at the Time of ModificationClick to enlarge

The Treasury’s findings were enlightening:

  • The longer the borrower stays in HAMP the better the chances of not re-defaulting.
  • Monthly payment reduction is the biggest driver of reduced re-defaults.
  • The sooner one gets into the HAMP the lower the chances of re-default.
  • Borrowers with better credit scores who enroll early in HAMP are less likely to re-default.

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The Special Inspector General of TARP (SIGTARP) also found that, of the HAMP re-defaulters, 22 % have entered into the foreclosure process[x]. SIGTARP also found the percentage of modified homeowners who end up as re-defaulters has steadily increased over time. At the end of 2009, the share stood at 1 percent and has since risen to 26 percent as of April 2013. The likelihood of falling out of the programme also seems to increase over time. SIGTARP also found that only 21% of funds earmarked for HAMP have been deployed to date; so there remains plenty of firepower to throw at this programme. Treasury is making the case for HAMP but SIGTARP is saying that HAMP is not working.

HARP and HAMP are both broken. Clearly the Federal Reserve and the Federal Government are compiling their collateral to justify further intervention in the housing market later this year if the recovery stalls. The recent stumble in relation to the “Taper” suggests that this intervention has moved a step closer.

In Housing Smoke and Mirrors “Re-tuning the HARP” earlier reference was made to the phenomenon termed “Burnout” in the April Lender Processing Service’s Mortgage Monitor [xi] ,which was observed in Housing Smoke and Mirrors “Exit Rush”[xii]. In “Exit Rush” we said that:

“What is termed “Burnout” was also observed in the post-2009 Vintages. Modification eligibility through HARP is limited to pre-2009 Vintages, which are seeing healthy use of this programme and refinancing. Post-2009 vintages have exhausted most of their refinancing possibilities. Pre-2009 Vintages are now most as risk from the backup in interest rates. Even once they have been modified through HARP, the rate of interest may now be too high for the borrower to sustain. Risk is therefore growing in the pre-2009 Vintages; and there is also limited room for improvement in the post-2009 Vintages. The improvement in prepayments for borrowers with low credit scores may therefore be stalling out.”

It was this “Burnout” that we suggested was responsible for the New York Fed to advance its proposals for HARP fine-tuning. The latest LPS report signals that delinquencies began to spike in June[xiii]. From May to June, the delinquency rate jumped by 9.9% to an annual level of 6.7%, which is the highest level seen since February. The foreclosure rate remained steady; which suggests that an inventory of distressed properties is building again. If these delinquencies are in Judicial States they will take a long time to show up as foreclosure sales. There is a latent inventory of distressed properties building again; and clearly the Federal Reserve and Federal Government wish to modify HARP and HAMP to deal with them.

The Fed having just triggered this delinquency build up, as Bernanke popped the Risk Asset bubble back in April[xiv], is now moving swiftly to remove it. In parallel with HARP modification the Fed is also boosting its balance sheet with MBAS purchases.

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Released On 7/25/2013 4:30:00 PM For wk7/24, 2013

For the July 24 week, the Fed balance sheet increased $36.7 billion after expanding $33.8 billion the prior period. The latest advance was led by a $36.4 billion boost in holdings of mortgage-backed securities with Treasuries gaining $8.3 billion.
Total assets for the July 24 week were at $3.575 trillion.
Reserve Bank credit for the July 24 week grew $39.0 billion, following a rise of $21.3 billion the week before.

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Freddie Mac is also testing the depths of liquidity in the waters of Private Capital; to see how much appetite there is to assume more of the GSE footprint in the housing market[xv]. About 50 broadly diversified investors are participating in a $500 million offering by Freddie Mac of Structured Agency Credit Risk (STACRSM) Debt Notes. STACR debt, the first in a series of such offerings, is also the first attempt by the company to reduce its exposure (and thus Taxpayers’ exposure) for some single-family mortgage risk. The notes are not guaranteed by Freddie Mac. This is a gradual risk transferring feature in which the first loss is taken by Freddie but quantified by a formula. Private investors then take losses in excess of that taken by Freddie. The spread is on Libor (+340 bps) and therefore is attractive and also hedges investors against rising interest rate risk. This is a trial offering for Freddie to learn the appetite of the market for risk; and other offerings will follow. At the same time as Freddie appeared to be trying to shrink its footprint, it reported that in actual fact its footprint was getting bigger[xvi]. In June, it reported that its mortgage portfolio was growing at an annual rate of 0.5%. Mortgage related securities and other guarantee commitments increased at an annualized rate of 5.6 percent in June compared to 2.2 percent in May. The only way Freddie can truly shrink its footprint is by passing on the risk, to the Private Sector, at the kind of spreads that compensate for the loss of the Federal Guarantee. Such spreads will get passed on to borrowers, which will immediately make the delinquency situation get even worse. If the Fed then carries out its pledge to “Taper” and exit, the borrowing costs with no Federal Guarantee will push many borrowers into default and drive away new home buyers. Clearly the Fed and the Treasury are modifying HARP and HAMP, with a view to dealing with the collateral damage that the reduction of the GSE footprint will create in the housing market. Evidence from Freddie Mac suggests that this footprint is not shrinking anyway, so the Taxpayer is still the main driver of the housing market; and will probably become an even bigger driver as interest rates rise.

This report has focused on the state of the Existing Home market. The weakness is also showing up in the New Home sector however.

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As progress is made removing the overhang of distressed homes in inventory, this has a negative impact on New Home Sales, which must compete on price with the existing supply. The Existing to New Home Sales Ratio suggests that there is still a long way to go before things are back to normal.

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Consequently in the “Taper” weakness in the existing market, home builders had to exercise more discipline in controlling their own operations. In June, even though New Home Sales rose, their prices fell thirty thousand Dollars on average. New Home Sales have just been able to penetrate above the previous recession floor.

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On the recent weakness in the Existing Market however, builders have cut back on Starts and reduced the number of Completions. It is fair to say that the builders are also playing the inventory game that the banks are playing to maintain prices. The rising interest rate picture has increased the supply in the Existing Sector however, which has put greater pressure on the New Home Sector.

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References

  1. Fannie Mae Expects Rates to Continue Higher
  2. NMHC Survey: Apartment Market Conditions Tighten slightly in July
  3. US Housing Prices Within 7% of 2007 High – That’s Not A Bubble?
  4. LPS Mortgage Monitor: May 2013 Mortgage Performance Observations
  5. Speech: Chairman Ben S. Bernanke
  6. New Freddie Mac Debt Notes to Transfer Risk to Private Sector
  7. Freddie Mac’s Total Portfolio Ticked up in June
  8. Survey: Current Homeowners Increase Purchases, Investors Exit Market
  9. Investor Purchases Slow Over Last Year as Short Sales Pick Up
  10. Report: 16 Markets Reach Full Recovery in May
  11. New Delinquency Roll Rates Continue to Improve
  12. Distressed Residential Real Estate: Dimensions, Impacts, and Remedies
  13. Understanding HAMP Re-Default Rates
  14. Report: 26% of HAMP Borrowers Redefaulted, Rate Continues to Worsen
  15. Housing Smoke and Mirrors (10) – “ Exit Rush”
  16. LPS: Delinquency Rate Sees Abrupt Increase in June

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