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A wild ride in the bond market
The MBA Mortgage Application Index was basically flat, closing out the week at 495.4—slightly higher than the 494.4 it posted the week before. Last week looked pretty boring if you only focused on the weekly change in the markets, but a lot went on. The action began Wednesday, with a better-than-expected GDP report that caused bonds to sell off. The ten-year yield tested its resistance level at 2.74% and then fell back, as investors interpreted the Federal Open Market Committee statement as dovish (not aggressive). Finally, on Friday, we had a weaker-than-expected jobs report, which put further strength in bonds. So basically, the ten-year traded in a wide range of 2.57% to 2.74%, but was unchanged for the week. For mortgage-backed securities (MBS) investors, it was like a roller coaster: dizzying heights, stomach-churning drops, and you end up in the same place you started, with less money in your pocket.
Mortgage bankers had an extremely profitable 2012, as rates fell and real estate prices bottomed. You can attribute much of the activity over the past five years to “serial refinancers,” people who have equity in their home and have taken advantage of refinance opportunities as rates have fallen. These borrowers are highly price-sensitive and tend to go with consumer-direct lenders who offer low rates and reduced application fees. These consumer-direct lenders will struggle in a purchase environment, and they’ve been laying off staff in anticipation of a drop in volume.
The purchase market is much more relationship-driven. This market requires a branch system of local professionals who have a large network of realtors, real estate attorneys, and similar professionals. These bankers compete on the basis of price and service. This also means there’s competition for independent brokers and bankers. A mortgage banker can grow very quickly through M&A (mergers and acquisitions) activity.
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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