BondSquawk

By Adam Metzger – Bondsquawk.com

July 16, 2010

Another interesting point from Gluskin Sheff’s, David Rosenberg’s piece this morning concerns the recent Mortgage Apps data:

For the week ending July 9, the Mortgage Bankers Association mortgage applications index fell 2.9%, the first decline in three weeks, despite the fact that mortgage rates remained at near record low during the reporting week. In a sign that people who can refinance have done so, the MBA’s refinancing activity index fell 2.9% as well on the week, reversing some of the gains we saw in the prior two weeks when refi activity surged 22%.

However, the story remains in the purchase index, which extended its losing streak to four consecutive weeks (or nine of the past 10 weeks), down 3.1%. The level of the purchase index now stands at 163.3, which is the worst reading we have seen since 1996 and is now 44% lower than the interim peak we saw back April. Averaging out the first two weeks in July, the purchase index is down another 5% from the June average. So consider this trend, May -18%, June -15% and now -5% … now that’s a trend that can’t be ignored.

During the first quarter of ’09, which coincided with the beginning of the Fed MBS program, mortgage rates dropped over 150bps within a two-month period.  This sharp move in rates led to a mini refi-wave(“mini”, because the index reached 10000 during the refi-wave of ’03), as the MBA refi-index rose to 7414 in early January ’09 followed two months later by an additional 40bp drop in the mortgage rate with another spike in the index up near 6800.   Currently, mortgage rates are at or near their lowest levels of all-time, yet the Refi-Index is half the level seen during the highs of ’09.  This drastically muted refi-response can be attributed in large part to a “burn-out” effect on the part of the borrower, and continued tight lending standards on the part of the lender.  “Burn-out”, essentially measures the borrower’s refi-responsiveness to lower mortgage rates during a certain period.  As borrowers are repeatedly exposed to more refi opportunities over time, they are less likely to respond to the next opportunity from both an economic and behavioral standpoint.

The story of lending standards (or lack thereof), is one that has played out and been highly publicized since the credit crisis began.  As the new world order took hold of the housing/lending market in ’09, lenders quickly changed tack from a very lax environment and became extremely defensive on which borrowers met the standards of either being able to refi or purchase a home.  The worse a borrower’s FICO and LTV, the less likely they would be given the opportunity to take out a loan.  For most of 2009, this lending consisted primarily of Freddie Mac and Fannie Mae securitizations, while Ginnie Mae became the new subprime lender.  Yet, since the beginning of the year, even Ginnie Mae has begun instituting much tighter lending standards, as the delinquencies on newly originated Ginnie Mae mortgages began to spike and cause losses to pile up in the GNMA portfolio.  At this point, the pool of willing AND able borrowers has become decisively smaller, as fewer and fewer parties are able to meet the pristine credit criteria of the lender in order to even take out a loan.

This muted refi response can also be seen in the securitization market, as dollar prices of premium MBS have continued to reach all-time highs nearly each successive week.  The typically negatively convex behavior of high-dollar price MBS has essentially been removed from investor psychology, as the market has become accustomed to the idea that speeds will continue to remain muted for some time to come.

In order to see any meaningful spike in refi activity, mortgage rates would need to drop below 4.50% to draw in significantly more borrowers.  And even in this case, the only eligible borrowers would most likely be those who missed their opportunities to refi during the first quarter of ’09, and have a credit profile so clean that you could eat off of it.  For the most part, the rest of the folks are locked-into their current rates, unless they can find a lender who’s willing to take on some risk to their balance sheet.

The implications of this dynamic could portend a long, gloomy recovery for a housing market that seems to be coming off of the government-induced highs of last year and is looking for the next crutch to bring it back from the abyss.  Looking at Rosenberg’s final point regarding the markedly declining trend in the Purchase Index over the last couple of months, it is interesting to note the correlation of this movement with the expiration of the Homebuyer Tax Credit.  We must ask ourselves at this point, just where will the buyers of homes come from if lending standards remain tight and credit remains scarce?   Of course, as we have seen in the past, the government’s ongoing foothold in this particular market has given them the ability and capacity to change the rules without a moment’s notice and make the impossible possible.