Mortgage Rates increase slightly, more increases ahead
Mortgage rates increase as the market makes new forecasts about quantitative easing
Mortgage rates are the lifeblood of the housing market, which is why Bernanke and the Fed began conducting quantitative easing (or QE) in the first place. Lower rates allow homeowners to refinance, which increases their disposable income and helps stimulate economic growth. Lower rates enable first-time homebuyers to move out of an apartment and into a house, which means higher consumption (and good things for home improvement retailers like Home Depot and Lowe’s). Consumption accounts for some 70% of the U.S. economy, and consumption has been depressed since the housing bubble burst. The Federal Reserve would prefer to keep rates as low as possible for as long as possible.
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Mortgage rates fall as the ten-year bond yield increases
The average 30-year fixed-rate mortgage fell by a basis point as the ten-year sold off, and TBAs followed. With the refinance boom over, originators are overstaffed and cutting prices to drive business. We’ve seen a number of small originators go out of business, as they found themselves unable to compete in a purchase-driven mortgage market. The purchase market is fundamentally different from the refinance market in that it’s driven by relationships and not price. We’ve seen big drops in mortgage banking activity at the big banks in Q3.
We saw Nationstar recently miss earnings based on falling refinance activity. The stock was hit hard, as we saw the effect of higher interest rates on refinance activity. The expected confirmation of Mel Watt as FHFA Chairman might give originators a break, as he’s expected to endorse further government homeowner assistance, which could mean an extension of HARP (Home Affordable Refinance Program) eligibility dates. This could trigger a new refinance boom.
Last week, the FHFA issued new loan level pricing adjustments for conforming loans. Loans with FICO scores above 680 and loan to value ratios above 80% will see higher rates. Not only that, but the FHFA increased the guarantee fee for conforming loans by 10 basis points. Conforming loan rates are no so high that jumbo rates are better. This should force more borrowers to seek private label financing for their mortgages.
Effect on homebuilders
Homebuilder stocks, like Lennar (LEN), Toll Brothers (TOL), Standard Pacific (SPF), PulteGroup (PHM), and KB Home (KBH), have rallied strongly over the past year, but they’ve given up ground since Q2 earnings. We’re starting to see some mergers and acquisitions activity in the homebuilding space, with Tri Pointe (TPH) buying Weyerhaeuser’s (WY) homebuilding unit and Toll Brothers buying Shapell.
Given that the economy could have depressed household formation numbers, there’s real pent-up demand for housing. Housing starts have been below historical averages for the past ten years. With low mortgage rates and increasing demand—and a strengthening economy—homebuilders now have the wind at their backs. The builders that have exposure to the red-hot West Coast market did very well. For homebuilders, the top-down macro picture looks good.