Oct. 18, 2012: Bank earnings are solid; gfee chatter - who's buying "dem" mortgages? And what are they buying?
Rob Chrisman
Pay
no attention to those stories about "Shadow Inventory"!
Apparently that has all been soaked up. Or, at least, builders
and the NAR would like to believe that. It is hard to pick the
top or bottom of any market, but it is hard to argue that
housing prices are still heading down. Even the USA
Today (“McPaper”) headline today was about improving housing
prices. The most recent Residential Price Index from FNC
reveals that prices for non-distressed homes rose for a
consecutive six months to hit their 20-month peak as of this
August. They increased a mere 0.3% from July but year-to-date
has increased 5% from January, which reflects the overall
strengthening of the housing market. Not only is purchasing
activity on the up, foreclosure sales dropped from 23% to
17.4% over that same time period. Of the 30 metropolitan
areas tracked by the index, those in the Western U.S. had the
highest month-to-month price improvement, with prices in Los
Angeles, Phoenix, and Sacramento all increasing more than 2%
from July to August 2012. The Phoenix area, which has pretty
strong momentum at this point and has been hailed as leading
the housing recovery, also displayed the strongest
year-to-year growth, with prices improving 13.3%. There’s a
trend towards positive year-to-date movement all over the
country, however, as is revealed by price increases in places
like Detroit, San Francisco, and Washington D.C.
The
Commerce Department reported that Housing Starts surged
15% in September to its fastest pace in more than four
years signaling that the housing sector's recovery is gaining
some momentum. Starts grew by 872,000 units on an annualized
basis, well above the 768,000 expected. Building Permits, a
sign of future construction, increased by more than 11% to
894,000 units annualized, above the 815,000 expected. Even RE/MAX
reported that home prices have increased from levels since
last year with median prices gaining 7.8%. In addition,
inventory levels have declined by 29% since last year. The
lower inventories have actually spurred on bidding wars in
certain sectors around the nation.
And
over the last few months the National Association of Realtors
(NAR) has been making some general statements that tight
inventories of existing homes are "in some locations"
impacting home sales. And this week the California Association
of Realtors (C.A.R.) confirmed that they are one of those
locations. C.A.R. said that "A continued shortage of available
homes for sale lowered California home Sales in September,
while the median price reached the highest level in more than
four years." Catch the wave – buy a non-owner! Why not –
the cash in most bank accounts is earning 0%.
"Rob - you really showed your age yesterday in your write up
about gfees. Not the write-up itself, but in your note
about the buy up ratio. You mentioned 2:1 or 3:1 – that was
when dinosaurs roamed the earth. Try Freddie and Fannie
charging lenders - and therefore borrowers - 7:1 or 8:1.
So a gfee of 40 basis points will cost about 3 points to buy
it down to 0, and allow a 3.25% loan to be put into a 3%
security. Fortunately 3% Fannie & Freddie MBS are priced
around 105 because the government is buying all our
production, so there is some room to play."
Which brings up the question, "Who is buying all those
mortgages that LO's are churning out, and what are they
buying?" The Treasury International Capital (TIC) report for
August showed strong demand for dollar assets from
foreigners. Foreign inflows into Treasuries totaled +$43
billion, while corporate bonds and stocks saw +$11 billion and
+$6 billion in inflows, respectively. The inflow into US
corporate bonds was the strongest since July '08. In Mortgage
Land, which some say is between Candy Land and Nowhere Land,
in August agency debt and MBS held overseas increased by $18.6
billion, which consisted of a $17 billion increase in MBS
holdings and a $1.5 billion increase in debt holdings. This
was the largest increase in Agency holdings so far this year.
Within the MBS sector, the $17 billion in net purchases was
offset by $14 billion in estimated prepayments, resulting in a
net increase of about $3 billion in MBS holdings after
accounting for prepays. Asia accounted for over $12B in net
purchases in August, while Europe was also a large contributor
with net purchases of $8B, mostly out of the United Kingdom
and Luxembourg. (Shouldn't they be using that money to buy
their own debt - like we do?)
Good LO's and well-run companies are continuing to say that
demand is robust for home loans. But few banks want
huge amounts of 30-yr fixed rate paper on their books. The
yield curve is pretty flat right now (20-year rates are only
about 175bp greater than 5-year rates). Banks know, however,
that long-term fixed-rate lending is at fundamental odds with
its asset/liability structure. (Put another way, when rates
move higher and banks are paying depositors 4% on their money,
they don't want to be earning 2.5% on the mortgage holdings.)
Traders are seeing banks interested in interest rate swaps,
since banks are compensated mostly for taking credit risk in
the loan portfolio and not interest rate risk. An interest
rate swap gives the borrower a fixed rate loan (stabilizing
cash flow) while the bank enjoys a variable rate (better
matching funding sources). Banks can continue to lend and earn
fees, so while the underlying benefit of loan hedging lies in
mitigating interest rate risk the primary benefit is continued
lending.
But what residential agency mortgage-backed securities is
everyone buying? Perhaps rascally 2.5% 30-years, filled
with sassy 2.75-3.125% loans? Or perhaps 3.0% 30-year MBS,
filled to the brim with 3.25-3.625% loans? Or how about those
ancient 3.5% pools, or even higher rates, with that big risk
of paying off early? Maybe the borrower's whose loans fill
those pools can't refinance! The markets like to watch who is
doing what, and the Fed is happy to oblige us with
transparency. Recently the Fed has increased purchases in
30-yr 3's at the expense of 3.5's. And Fed gross
purchases for the week ending October 10 were about $15
billion, lower than the $19 billion the prior week. This
decline largely reflects the effect of the Columbus Day
holiday and purchases remains consistent with buying $4bn/day.
The Fed increased its gross purchases of 30-yr conventional
3's to 53% of the total compared to 50% the prior week. This
was accompanied with a decline in 3.5's to 6% from 9%. The
overall share of 30yr conventionals remained steady at 60%. The
Fed also purchased $150 million in Fannie 2.5's. The
purchase share of Ginnie 30-yr 3's also increased slightly to
14% from 13% the week before, while 3.5's declined to 5% from
7%. The Fed continued to stay out of the Ginnie 15-year
sector, but purchases of 15-yr conventional 2.5s stayed at 18%
of gross purchases. Overall purchases of 15-yr conventionals
were also steady at 21%, and for the first time the Fed
purchased $150 million in Fannie 2's.
On the hedging side, traders report that the overwhelming
hedge coupon of choice was the Fannie Fannie 3% with over 80%
of 30-yr hedge activity in that coupon compared to over 90%
last week. The 30-yr 2.5% coupon has been slow to gain
liquidity, and is less than 2% of hedge volume. No one wants
to sell something they can't buy back!
Bank earnings continue to come in, and to no one's
surprise, they're strong. Bank of America
reported better than expected net profit of $340mm ($6.2B
prior year), as it took hits for $1.9B in accounting
adjustments, $1.6B legal expense related to Merrill Lynch and
$800k in tax related charges. The bank reported revenue fell
to $20.4B ($28.5B one year ago); mobile customers surpassed
11mm; had a 48% drop in provisions for credit losses; mortgage
originations climbed 18% and small business lending jumped 27%
YOY. U.S. Bancorp reported record profit of $1.4B, up
15.8% over prior year. Compared to the prior year, average
total loans grew 7.3% (C&I up 19%, CRE up 21%);
noninterest bearing deposits climbed 16%; NIM was 3.59% vs.
3.65%; allowance was 2.26% vs. 2.66% and the efficiency ratio
declined to 49.1% vs. 50.0%. M&T Bank reported a
34c operating beat, benefiting from a surge in mortgage
banking revenues (+$0.21) as well as lower credit costs
(+$0.07). U.S. Bank reported operating earnings of
$0.76 per share this quarter, ahead of both our estimate and
the Street. The beat was driven by higher spread income
(+$0.01) and core fees (+$0.03), partially offset by a higher
provision (-$0.02) and expenses (-$0.01). Wintrust saw
strong mortgage banking results drove a 3Q beat as operating
EPS of $0.58 beat estimates. Northwest's Umpqua
reported 3Q12 EPS of $0.22, in line with consensus. Lower NCOs
drove a lower provision relative to our expectations, and
mortgage banking revenue was up over 50% q/q.
Interest rates have indeed slid higher. The smart money
thinks they’re going to slide right back down here in the
states. But if the European debt situation is stable, or
improves, Asia begins to heat up, or our economy starts to
pick up unexpectedly, all bets are off. Yesterday, for
example, we had stronger-than-expected Housing Starts and
encouraging news on Spain, which led to heavy locks &
originator selling, and eventually intra-day price changes. By
the “traditional 3PM EST” close (when the futures market
closes), agency MBS prices were worse about .375 in price and
the 10-yr. was at 1.81%.
For
thrills and chills today we have Initial Jobless Claims
(expected to increase to 365k), Leading Economic Indicators
(expected to improve) and the Philly Fed Survey for October. In
the very early going rates have improved slightly, with the
10-yr down to 1.80% and MBS prices better by about .125.
Old Butch
John was in the fertilized egg business. He had several
hundred young layers (hens), called 'pullets,' and ten
roosters to fertilize the eggs. He kept records, and any
rooster not performing went into the soup pot and was
replaced. This took a lot of time, so he bought some tiny
bells and attached them to his roosters. Each bell had a
different tone, so he could tell from a distance, which
rooster was performing. Now, he could sit on the porch and
fill out an efficiency report by just listening to the bells.
John's favorite rooster, old Butch, was a very fine specimen,
but this morning he noticed old Butch's bell hadn't rung at
all! When he went to investigate, he saw the other roosters
were busy chasing pullets, bells-a-ringing, but the pullets,
hearing the roosters coming, would run for cover. To John's
amazement, old Butch had his bell in his beak, so it couldn't
ring. He'd sneak up on a pullet, do his job and walk on to the
next one.
John was so proud of old Butch, he entered him in the Saint
Lawrence County Fair and he became an overnight sensation
among the judges.
The result was the judges not only awarded old Butch the "No
Bell Piece Prize," but they also awarded him the
"Pulletsurprise" as well.
Clearly old Butch was a politician in the making. Who else but
a politician could figure out how to win two of the most
coveted awards on our planet by being the best at sneaking up
on the unsuspecting populace and screwing them when they
weren't paying attention.
Vote carefully this fall, the bells are not always audible.
If
you're interested, visit my twice-a-month blog at the STRATMOR
Group web site located at www.stratmorgroup.com.
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