Weekly Mortgage Rate Review, July 16, 2010

Mortgage rates liked the weather

The old trader’s adage, “Sell in May and go away”, reflected the traditional experience of little market activity of significance during the summer months. Since this is prime vacation time, the unwritten rule was for everyone to try to keep any drama out of the markets during this time. Well, we now live in a 24-hour news cycle world. We have an economy that is globally interdependent. Unfortunately (for many of us), markets can and do see drama regardless of the season. However, as we now know, it’s not the season but rather the weather that matters—meaning the economic environment on an hour by hour, day by day basis. In the past we may not have known about an economic thunderstorm until days later. Today we have economic Doppler radar (reports, events, meetings, etc.), showing us every economic event in real time.

One problem we all share with our poor, abused, local weather-person is that it is quite difficult to forecast the weather precisely. We have lots of data, but accurately predicting the direction of the economy or of mortgage rates is quite difficult. Since this article is a review of the weekly mortgage rate activity, I am, therefore, fortunate. My forecasting prowess is excellent in reverse! This week the weather was good for mortgage rates.

A reverse forecast

As I gaze into my crystal ball of mortgage rates I see a week that started slowly on Monday with little change initially and very little data or news. However, a rally in mortgage-backed securities brought price improvement by midday only to give it back by the end of the day. A lot of movement was seen on Monday with very little actual change.

Tuesday brought a stock market rally and corresponding sell-off in bonds and mortgage-backed securities. Mortgage pricing worsened, but again only slightly. The weather improved for mortgage rates on Wednesday as signs of economic weakness appeared on the Doppler. Retail sales were weak and the Federal Open market Committee of the Federal Reserve released the minutes of its recent meeting in which it was clear that members see a slowing economy. Stormy economic conditions lead mortgage rates down.

On Thursday gloomy skies persisted as the manufacturing sector showed signs of a slowdown and inflation appeared nowhere to be found, raising fears of deflation. Friday started well with a major stock sell-off and mortgage pricing improvement through the morning. Yet, despite escalating losses in the stock market , the mortgage-backed securities market gave back all of its morning gains and lenders were forced to bring mortgage rates back to their starting point at the beginning of the day.

Bad economic weather brought sunshine to mortgage rates for the week. Mortgage pricing improved by a significant amount this week resulting in lower rates (best available around 4.5%) and lower discount fees (money paid by borrowers to obtain a certain interest rate from a lender).

Are lenders involved in a price war?

Over the past several weeks the data clearly show that certain large lenders, not all at once, but in sequence, have priced loans at lower margins than is typical. This means that lenders are getting less from borrowers relative to what they have to pay to sell loans they originate in the secondary market. I have surveyed several originator friends of mine regarding this question. I have agreed to keep them anonymous due to the sensitive nature of the topic. Some of those surveyed were mortgage brokers (they offer loans from many different lenders), some were correspondent lenders (they fund loans but immediately sell to one or more lenders) and some were direct lenders (they provide the loans directly to borrowers). The consensus is mixed.

Some of those I surveyed said that there is, without a doubt, a pricing war going on in which certain lenders are offering rates much lower than the market says should be available. Others suggest that there is simply a rotation among lenders offering the lowest rates and that this corresponds to their internal production capacity (“we can only do so many loans with the resources we have”). The later theory is: when production capacity is available, lenders lower rates to capture more business and maximize their resource utilization; then when resources are taxed, lenders raise rates to avoid capturing business.

I frankly don’t buy the argument that lenders are lowering or raising rates based on their production capacity. Loan production resources are increased or scaled back to easily in response to market driven volumes. Something else must be at work here. What could it be?

Here are my thoughts.

First, this week brought us the earnings reports from several large lenders. Generally, with the exception of Citigroup, these reports were positive—until you look a little deeper. The common theme among these large banks earnings reports was good profits, but low revenues. Most of the profit came from cost savings or other non-productive activities. I believe that one explanation for the “buying of business” in the form of lower rates than are seemingly justified; is a desperate attempt to increase revenues. While the earnings reports would not include any loans made after June 30, the aggressive loan pricing can still help the banks generate revenues going forward into what they all said was a “challenging” period in the second half of 2010. Only making matters worse is the uncertainty associated with the passage of the Financial Regulatory Reform legislation on bank’s costs and ability to generate revenues.

Second, as we have discussed previously, there simply aren’t that many borrowers left who can qualify to get a mortgage or a refinance. Credit issues, home value issues, consumer debt aversion and tougher lending standards have greatly reduced the pool of potential mortgage borrowers. With rates ultimately headed up, it makes perfect sense that large lenders would be fighting for the remaining business and willing to make a little less than usual on each transaction. Borrowers who can qualify will be the ultimate beneficiaries. For them, “a little war is a good thing”!