Why mortgage applications are falling as rates rise



Mortgage applications fall slightly

The MBA Applications Index rose 0.6% after rising 2.6% 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.

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The government shutdown was expected to reduce mortgage activity, as some important functions were not undertaken—particularly income verification at the IRS and identity verification via Social Security. Many originators chose to continue to originate loans without IRS verification for borrowers with verifiable wage income.

The Fed is the elephant in the room

The Federal Open Market Committee voted to maintain its current pace of asset purchases after warning the market it would begin to taper last spring. The surprise move caught the market leaning the wrong way, and short covering drove a swift rally in bonds. Many people who had thought they missed their window to refinance or purchase a home took advantage of the dip in rates.

Subsequently, there has been some stronger-than-expected economic data, along with some comments from regional Fed governors that tapering should begin sooner than later. The October FOMC statement was considered less dovish than the market had hoped.

Survey of the landscape for 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. Last week, Fannie Mae just did its first risk sharing deal, which is the first step towards this new environment.

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 US government bears 50% of the credit risk of the entire US 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, but subsequently, spreads have widened and the deal flow has slowed. In fact, just this week, Shellpoint Partners abandoned a planned securitization. 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). Servicing has increased in value tremendously ever since rates started rising, with newly originated conforming mortgage servicing rights trading at four times cash flow.


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