Hopes and Doubts on the Home Front

 | Jun 29, 2013 | 1:30 PM EDT  | Comments
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Housing stocks seemed to be rolling over for a moment last week as the markets reacted negatively to messages from the Federal Reserve and Chairman Ben Bernanke. Reaction to the central bank's statements on quantitative-easing tapering and anti-exuberance, some now say, were misimpressions. Nonetheless, Radian (RDN), the early-recovery bet among the high-beta mortgage insurance (MI) stocks, took a big hit, dropping 20% from its mid-May highs. Shares of SPDR S&P Homebuilders (XHB) lost 12%, while iShares Dow Jones US Home Construction (ITB) shed 15% of its share price.

So is the housing story done? How about mortgage finance?

The answers from industry sources in Washington are unambiguous. Housing seems to be in for a steady, long-term recovery, helped by demographics and a climb from sharp lows. I, too, would say that the housing and homebuilding stories are anything but over.

By contrast, mortgage originations -- which had been boosted by a now-gasping wave of refinancing -- have entered a decline. The mortgage business overall may fall at least through 2014. However, the steadying transition to higher purchase mortgage volumes should continue to make the MI stocks -- or, for that matter, servicers like Ocwen (OCN) and Nationstar Mortgage (NSM) -- positive long-term plays on the housing recovery.

I offer a mishmash of great charts that tell the story here, cherry-picking separate decks from the best forecasters in the mortgage and housing groups.

Housing and Mortgage Rates Going Up, Loan Originations Are Down

The Echo Boom generation, comprising people born between 1985 and 2004, has spawned more than 20 million first-time homebuyers. That's a higher number than that of the much-ballyhooed Baby Boom set, as Eric Belsky -- Harvard's standout head of the Joint Center for Housing Studies -- reminded a group I helped host last week. Amid changing lifestyles and the challenges of a transitioning and deleveraging economy, the Echo Boomers are sometimes characterized in unflattering terms. For instance, Rep. Paul Ryan (R-WI), the 2012 GOP vice-presidential candidate, spoke of "college graduates [living] out their 20s in their childhood bedrooms, staring up at fading Obama posters and wondering when they can move out and get going with life." But, according to Belsky, members of this generation still aspire to own a home.

Meanwhile, the Echoers represent a more diverse cohort than do the Boomers, with 45% of the age group counted as minority members vs. 28% of the older generation. This heightens challenges for lenders, who are at greater risk to disparate-impact lawsuits if they continue relying on credit scores. More broadly, adverse credit conditions are restraining household formation, while an uptick in renters are reducing the number of homebuyers. Other policy issues have also played a role, such as the Dodd-Frank rules to ensure borrowers' "ability to repay" and lenders' retention of risk in securitizations. But these issues should gradually subside as clarity emerges.

Suffice it to say that loans backed by the Federal Housing Administration, and by Fannie Mae and Freddie Mac, have been the only game in town for several years now. Together, they represent more than 90% of originations. Meanwhile, egged on by lawmakers and regulators alike, Fannie and Freddie have squeezed the credit box tightly by making fewer than 15% of their loans to borrowers with FICO scores below 680, compared with 98% in the boom year of 2006. The FHA, as the last resort of low-income and low-money-down borrowers, has similarly seen these ratios fall from 75% to 40%.

In this scenario, I see four wild cards.

1. Might regulators, and legal and policy risk, let up soon enough to allow lenders to expand the credit box?

When it comes to this issue, hope seemed to arrive earlier this year: The Consumer Finance Protection Bureau's "Qualified Mortgage" rule turned out less restrictive than expected. This has prompted talk along the lines of "let's not and say we did" concerning synchronization of the rule with the problematic "qualified residential mortgage" (QRM) standard -- which defines the loans that qualify for protection from a 5% risk-retention charge. There's at least some optimism here as we await the July 2 release of new Basel III capital rules, which will govern risk weightings for mortgage assets held by banks in the future.

Nonetheless, doubts remain about whether horse-whispering to lenders might lure them into removing credit overlays on FHA loans -- which the Federal Reserve has partially blamed for a 50% drop-off in first-time homebuyers. The widening of the credit box will happen only slowly. Congress is unlikely to approve a more lenient Fannie-Freddie regulator anytime soon. Constricting FHA reforms, moreover, are likely to precede this fall's consideration of an ambitious reform bill on government-sponsored enterprises (i.e., Fannie and Freddie).

2. Might economic conditions improve enough to create jobs and stave off characterizations of a secular change in employment?

If so, it could allow the Echoers to move out, buy up and more than offset the effects of Boomers' downsizing of their homes as they retire over the coming decade. I'll leave it to the economists, but this one also suggests a slow and steady slog, albeit increasingly in the right direction.

3. Might rising interest rates curb homebuying over the next couple of years as Bernanke and company dismount from their QE highwire?

I asked this question at every stop on a housing field trip earlier in the week, and I got two reassuring answers. First, even with the climbs in home prices and in mortgage interest rates, homes are still more affordable now than they have been in 40 years. See the chart on slide 5 (PDF) from the National Association or Realtors (which has been modified to more than reflect the recent blip up in 30-year fixed rates to 4.5% or higher.)

Second, historical data from the National Association of Home Builders suggest that single-family housing starts are about halfway back to the 1.3 million annualized rate that we saw during the base years of 2000 to 2003, and they should rise to 70% with little trouble by 2014. Perhaps even more consolingly, in the near term interest rates might have to rise as high as 6% in order to reach a pain threshold that will throttle down pent-up demand.

4. Whither goest mortgage originations and the refi wave?

The biggest fly in the ointment may be that rising rates will more than offset the Obama Administration's efforts to juice the last mile of the mortgage-refinancing wave.

Refinancings accounted for 70% of the 1.7 million originations in 2012. They are now expected to generate barely one-third of the total, or 1.1 million originations, by 2014, according to the Mortgage Bankers Association. But purchase mortgage volumes should increase 18% or so this year and next, per the MBA. That's a good thing, and it should be impervious to rising rates.

However, we can now pretty much discount earlier hopes that we'll gain a quarter- to a half-million refis due to aggressive marketing of the advantageous Home Affordable Refinance Program (HARP) (spearheaded by Treasury, the GSEs, MIs and the Federal Housing Finance Authority). Neither should we count on an even bigger yield from a HARP-expanding Senate bill from Robert Menendez (D-NJ) and Barbara Boxer (D-CA), whose passage on the Hill seems increasingly unlikely.

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