"With only a week to go
until St. Patrick's Day, Irish divers were amazed to find that, after 100 years
of lying at the bottom of the ocean, the Titanic's swimming pool was still
full." The Irish are one of the few groups that appreciate a joke about
themselves, and I used this to illustrate that things aren't always what they
seem. For example, the U.S. seems to be doing okay, yet the Treasury Department
reports that given the projected budget deficit, for every $1 of expected tax
revenue, our government anticipates spending $1.25. Is that any way to run a
government, or a family?
Every lender & servicer,
and therefore borrower, is influenced by the price of servicing. And
in recent months we have all seen large blocks of servicing being sold and
bought. There was a note on the topic: "I have a basic understanding of
how the price of a loan is based on the value of the asset - basically the
coupon passed through - plus the value of the servicing. The value of the asset
is based on the bond market, but what makes up the value of the servicing?"
I will be very brief, since very lengthy documents have been written about
valuing servicing. And easy way to explain it to someone else is in terms of
cash flow: there is more value in a series of payments that last a long time,
and are safe - just like anything else.
As part of the MSR (mortgage
servicing rights) valuation, servicing firms, investors, etc., enter several
different assumptions to come up with the valuation. These
include the float on principal and interest and prepayments (dependent on a
multitude of factors, not the least of which is how the lender is selling the
loan, and how the loan is being serviced), the cost to service a loan per year
(the more loans a company is servicing, the lower the cost per loan since
overhead is spread out), the discount rate (there are tiers for excess
servicing which doesn't apply on cash), the projected delinquency rates and
additional costs associated with delinquencies, earning rates on escrows,
escrow advances, and growth rates. Some prefer to put a cap on the multiples of
servicing - basis points that the MSR cannot exceed. But those are the basics,
and just like the bond market, the values and perceived values are always
changing.
How are Freddie and Fannie
doing? They're making some nice coin, but at the expense of borrowers
who are the mainstay of the cleanest, most thoroughly underwritten and
appraised, heavily documented loans in history. (Granted, some of this is going
to pay for a tax break extension - remember Congress voting that in?) The industry
and MBS investors are keenly interested in how credit is impacted by rates,
fees, guidelines, compliance costs, consolidation in the industry - it will all
be a real case study. But through its 10-k Fannie reported that its average
gfees went to 57.4bps in 2013 from 39.9 basis points in 2012, which was up from
28.8bps in 2011, including upfront fees amortized over expected loan lives. The
increase last year included 10 basis points in average base increase, greater
LLPAs on higher LTVs, lower FICO loans, and the fabled effects of 10 bps
increase passed through to government. Roughly 40% of net interest income in
2013 was from g-fees on loans in MBS, compared with ~30% in 2012, ~25% in 2011
- one can expect this trend will continue and in the near future g-fees will be
primary source of revenue.
So why is the U.S. downplaying
the huge profits at Fannie & Freddie? Wall Street Journal writer Nick
Timiraos points out that Michael Stegman, the Treasury adviser, warned that
those recent returns "may significantly overstate the true financial
condition" the companies, "especially on a go-forward basis."
Some of the profits came from one-time tax reversals as the companies reversed
huge write-downs they were forced to take in 2008. More came from releasing
loan-loss reserves and one-time legal settlements with Wall Street banks or
lenders. And just like homeowners out there, their financial outlook has
benefited significantly from strong home-price appreciation and low interest
rates, both of which may moderate in future periods.
Addressing the "why kill
the golden goose" question, Mr. Timiraos wrote that, "First, the
Obama administration doesn't want the profits to remove the urgency for
Congress to decide how to overhaul Fannie and Freddie. Some stakeholders 'mistakenly
argue that housing finance reform is no longer needed -- that the [companies]
are so financially flush' to reduce the need for legislation, he said. 'We
could not disagree more.' The administration has made clear it doesn't support
returning Fannie and Freddie to their former duopoly status as
'government-sponsored' entities that are neither fully private nor fully
public. The profits could not only remove the urgency for any overhaul, but
they could also lead lawmakers to grow more comfortable with less dramatic
changes whenever they get around to proposing such an overhaul." But
really... during an election year? There are many that say when there are
other, more pressing issues that Congress is having trouble coming to a
consensus on, not only is any substantive change proposal unlikely this year,
but everyone is in agreement that it will take years of work to implement.
Meanwhile, Ellie Mae
recently calculated that there is some evidence that it may have become a
little easier for some Americans to obtain a home loan. Looking at FICO,
which is only one score, the average credit score for approved mortgages fell
to 727 in December, down from 748 one year earlier. (FICO credit scores run on
a scale from 300 to 850.) The report said that some 46% of mortgages that
closed in December had credit scores above 750, compared with nearly 57% one
year earlier. Meanwhile, around 31% of loans had credit scores below 700, up
from 21% one year earlier. The data also showed that the average debt-to-income
of borrowers increased: loans closed in December were 39%, up from 35% in June
and 34% in January.
There are plenty of LOs who
will argue that this shows that the easier loans with higher credit scores have
been done, and much of what the industry has left are tougher to do.
Others will say that home prices have stopped falling and the economy is slowly
improving, making lenders more comfortable to extend loans. Big drops in
refinances, impacting volumes, could also lead lenders to become more
competitive for home purchases. We're already seeing an upswing in interest in
non-QM lending, and in lenders that offer that product. Analysts say it is
normal for borrowers with weaker credit to seek out refinancing as rates go up
and as the refinance cycle nears its end.
Let's see what lenders and
investors have been up to in recent weeks. But first a clarification to posting
Friday regarding United Wholesale Mortgage. ("United Wholesale
Mortgage has rolled out its new UWM Track, which allows brokers to track the status
of a loan in order to provide realtors with up-to-date information. When
viewing their loan pipeline in the EASE portal, brokers can see when a loan is
submitted to underwriting, has its conditions reviewed and cleared, been
approved, when prep and closing documents were sent to the title company, and
when it can be expected to fund.") The UWM Track is actually a service
that allows the Realtor to see the process of the loan. The broker provides a
realtor with a log in and password to a separate portal via UWM's website, and
the Realtor can actually track the loan in process.
Rates seem fairly content where
they are. Data last week provided further evidence that the economy has lost momentum
since the start of the year, although activity has not fallen off the cliff.
Nearly all of the monthly data seem to have been affected in some way by the
storms and prolonged cold that has plagued the United States since the year
started. Friday's employment data (a 175k gain in employment last month
followed by a revised +129k increase in January, beating expectations, and the
jobless rate at 6.7%) is still being discussed, but the strength led to a
selloff in fixed-income securities (including agency MBS which worsened about
.250).
This week is pretty light on
the economic calendar. Aside from some "third tier" economic numbers
that rarely move rates and whatever might happen overseas, we don't have
anything until Thursday's Retail Sales number which measures the total receipts
at stores that sell merchandise and services to customers. Weekly Initial
Jobless Claims and some Import Price numbers come out Thursday as well. And
then on Friday we have the Producer Price Index (PPI) to show us inflation at
the producer level (but inflation has not been an issue in a long, long time)
and the University of Michigan confidence numbers. Agency MBS prices are
roughly unchanged from Friday's close, and the yield on the 10-yr is sitting
around 2.80%.
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