Blog Category: Chrisman's Corner

One of the topics that was on the minds of the participants in last week’s MBA’s Secondary Marketing Conference was non-QM lending. More specifically, what is going on with it? The lending industry has been dealing with the “QM versus non-QM” discussion and decision for quite some time, and non-QM lending has not gained industry-wide acceptance. Qualified Mortgages have become part of the vernacular, and every day companies are weighing the risks of offering the product through retail, wholesale, and correspondent channels. QM, of course, refers to the federal Qualified Mortgage rules that are designed to foster “safe” lending. They ban certain loan features such as negative amortization and interest-only payments; set a 43% ceiling for debt-to-income ratios; and impose a 3% limit on total loan fees, among other requirements.

Of course, doing a QM loan does not shield Optimal Blue’s clients, or any lender, from a lawsuit in the future. It is important to remember, however, that non-QM loans do not equate to subprime loans. Lenders jumping into the non-QM space emphasize that they have no interest in funding subprime applicants who lack the ability to repay their mortgages. Many lenders, for example, offer products that allow debt ratios of 50% and depart from other QM standards for applicants who have strong compensating factors such as substantial down payment and reserves.

As OB’s clients know, several companies are known as the place to go for non-QM: Citadel Servicing, Angel Oak, Luther Burbank, BofI, and a handful of others, to name a few. Some call them “Alternative QM” mortgages for several categories of creditworthy borrowers with special needs. They are targeting near-miss borrowers who almost qualify under standard rules, but not quite. Say they have solid credit scores and good jobs, but have a debt-to-income ratio of 49%. They’re likely to have difficulty making it through Fannie Mae’s or Freddie Mac’s underwriting systems, but worthy of being given credit after taking a hard look at their bank reserves and assets.

Lenders are also addressing self-employed borrowers who have been left behind by QM rules and large lender underwriting guidelines. Business owners, for example, generally can’t show IRS W-2 forms and may have irregular income flows, complex tax situations and periodically high debt levels. Some residential lenders allow them to document their income using 12 months of recent bank statements and to have debt-to-income ratios as high as 50%. Also included in the product lineups are programs helping investors with multiple properties. They face significant hurdles when they apply for mortgages. Investors who own 10 or more rental homes or commercial properties and seek to refinance and pull money out are frequently turned down by conventional lenders. So some lenders evaluate borrowers’ incomes based on the properties’ cash flows and has no limit on total properties owned.

There is still concern about future liabilities, investor options if a closed loan isn’t purchased, reputational risk for offering non-QM product, and the sales job that LOs must give borrowers for the higher rate. Although this may change, non-QM lenders are looking for borrowers with high FICO scores and ample money to put down on the home, earning a low loan-to-value ratio. Ability to Repay, or ATR, is critical, and non-QM loans can be a good credit risk if the borrower demonstrates an ability to repay.

Investors are showing interest in the product. The government, indirectly, wants the industry to increase “private lending” and therefore do non-QM although the agencies have a waiver until they come out of conservatorship to go above the DTI limit. Despite their issuing a tough QM rule, financial regulators really want lenders to do more non-QM to decrease Freddie’s and Fannie’s share of the total mortgage market.

The Fed’s release of the minutes from its meeting last month spooked interest rates. Namely, OB’s clients and others saw them shoot higher as the writing indicated that some members of the Fed believe that the U.S. economy is doing just fine, despite what is occurring in other countries, and that a rate hike in June is certainly on the table.

The sentence that sent bonds reeling was that, “Some members expressed concern that the likelihood implied by market pricing that the Committee would increase the target range for the federal funds rate at the June meeting might be unduly low.” When traders and analysts hit that sentence the FOMC minutes caused a 7 basis point spike in the 10 year and a 6 basis point spike in the 2 year. The Fed Funds futures contracts (which is what the “likelihood implied by market pricing” phrase alludes to) moved from a 10% chance of a June hike to a 25% chance of a June hike and a 60% chance of a hike by September.

Optimal Blue’s clients know that the Fed doesn’t set mortgage rates. But it does influence bond markets. Earlier this year, the futures were basically betting the Fed would be on hold for the rest of the year. The markets were perhaps a little too complacent about another rate hike. That said, the Fed has set up the markets for rate hikes several times over the past year or two only to get cold feet.

In terms of the economy, the members and the staff noted that the labor market continues to improve despite a deceleration in economic growth. Inflation remains well below the Fed’s target, however they attribute that to commodity price movements, which are transitory. The minutes also mentioned that residential mortgage credit was getting a little looser on the government side, but also noted that non-traditional and credit-challenged borrowers still face tight credit conditions. The corporate bond market has improved after a slow January and February.

In this era when every word uttered by the Fed, either by a Governor during a speech or in the minutes of a meeting, are sliced and diced and analyzed, brings up the topic of communication. It is critical that central bankers have the ability to communicate their monetary policy goals and intentions involving employment and price stability to the public effectively and without a knee-jerk reaction like we saw yesterday. The task is complicated in an economy that includes many firms and households in an era of information overload.

The central bank’s primary policy instrument—the short-term interest rate—is near zero, a situation many advanced economies face today. The private sector relies on its perception of central bank economic expectations when it considers changes to its production of goods and services or the prices it charges for them. And central bank short-term policy rate changes (in both low-rate and more normal-rate environments) fulfill an informational role by transferring assessments about risks to the economic outlook.

The Fed runs the risk that readers & listeners may misinterpret the statements, leading to
an unintentional and counterproductive response, especially if the reader or listener has a short attention span! Central banks, with the explosion of new media outlets, have more opportunities
than ever to provide information. Thus, for a central bank to remain relevant, it must carefully ponder what to say.

This week’s minutes, and the reaction, impacted Optimal Blue and its clients. The increased volatility raises hedging costs and nervousness in the residential lending industry. Neither are good things.

Last week we talked about inflation. Or more precisely, the lack of inflation in the economy, and the Federal Reserve Open Market Committee’s thoughts on it. A small amount of inflation is generally thought to indicate a healthy economy, but it is truly a balancing act.

The FOMC’s meetings were in late January, mid-March, April 26-27, and are slated for June 14-15, July 26-27, Sept. 20-21, Nov. 1-2, and Dec. 13-14. Fed Chairwoman Janet Yellen will hold her quarterly news conferences after the March, June, September and December meetings, the Fed said. Why is this important? The bond markets tend to think that the Fed knows more about the economy than it does, and therefore takes its cue from the Fed’s actions.

I bring this up because a group of economists is now suggesting that rates in the United States will drop more. In fact, Citigroup is in the press saying that Treasury benchmark yields may fall to toward record-low levels on slowing U.S. economic growth and demand from overseas investors. The 10-year note yield may sink to 1.5 percent, U.S. rates strategist Jabaz Mathai wrote in a May 6 note to clients. That was after data last week showed the U.S. added fewer jobs than forecast in April, challenging the Federal Reserve’s quest to raise interest rates.

We’ve also written about negative interest rates in several countries. Debt holders actually pay the governments to hold their money! The United States has higher yields than most other developed countries, and this serves to boost the appeal of U.S. debt. This is especially interesting since the U.S. is viewed as the safest of places for investment, so one would think that would drive up prices and drive down rates.

But as we noted last week, there is little in the way of inflation at the moment, and thus there is more room for the Fed to stay on the sidelines,” Mathai wrote. “The longer end of the curve arguably has more room to move. We are partial to the view that a test of 1.5 percent is highly likely.” So once again the Fed is in a pickle, thinking that higher rates are in the cards but being subject to what happens overseas.

There was no expectation leading up the Fed’s meeting in late April that it would shift short term rates higher. And now, given the problems with various economies overseas, the odds of a rate increase in June are only about 4 percent. However, the “smartest guys in the room” are still giving a 44 percent chance for a rate hike by year-end, according to data based on fed fund futures compiled by Bloomberg.

Others, however, don’t see that happening. They think that anti-inflationary issues in the oil market, limited growth availability around the world, and a slow but steady economy here in the United States as having a dampening impact on rates. Economists at Goldman Sachs Group Inc. and Bank of America last week pushed back expectations for the next rate boost to September from June.

Most of Optimal Blue’s clients, and other lenders, for their part, are relatively happy about mortgage rates where they are. The smart ones realize that the focus is on servicing their clients, whether they be builders, real estate agents, or borrowers, rather than trying to guess where rates are going, or even hoping for lower rates. They know that lower rates may very well be caused by a slowing economy, and that is not what is needed.

Optimal Blue clients who have been around a while certainly remember when inflation was a concern. But folks who have been around only 5-10 years may not even give it a second thought. So it is probably a good time for a primer on inflation, measuring it, and how OB’s clients might be impacted.

When we think about inflationary measurements, the majority of us no doubt think about the Consumer Price Index (CPI) as the standard measurement of where prices are trending. According to the Fed, the CPI is a statistical estimate of the change in prices of goods and services which are consumed by… well, by consumers. More specifically, it is a measurement of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

The CPI reflects spending patterns for each of two population groups: all urban consumers and urban wage earners and clerical workers. The “all urban consumer” group represents about 87% of the total U.S. population. CPI is based on the expenditures of almost all residents of urban or metropolitan areas, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers. Not included in the CPI are the spending patterns of people living in rural nonmetropolitan areas, farm families, people in the Armed Forces, and those in institutions, such as prisons and mental hospitals.

But don’t forget the PCE, or Personal Consumption Expenditure, figure. It is currently the preferred method for inflationary measurement at the Federal Reserve. At its core the PCE is the component statistic for consumption in GDP. The PCE consists of the actual and imputed expenditures of households and includes data pertaining to durable and non-durable goods and services. It is essentially a measure of goods and services targeted towards individuals and consumed by individuals.

Although the CPI and the PCE are similar, currently when the Fed reviews economic conditions to decide what actions it will take to influence inflation and employment, it sets aside the an almost 100-year CPI tradition in favor of the PCE. Why? Mainly because the PCE includes a broader range of expenditures than CPI. It’s weighted according to data provided in business surveys, rather than the less reliable consumer surveys used to weight the CPI; it also uses a formula that adjusts for changes in consumer behavior that occur in the short term, something the standard CPI formula doesn’t do. The result is a more comprehensive, if less familiar, gauge of inflation. That’s important for the Fed, which regards a small amount of inflation as a sign of a healthy, growing economy.

When economists refer to “core” CPI, or “core” PCE, they’re referring to the underlying measurement, less food and energy, which can be seasonally biased. Core inflation has been on the rise since late last year, and the trend continues to strengthen. Core inflation has picked up noticeably since the FOMC decided to lift rates last December. The strengthening could be easily interpreted as “actual” progress toward the Fed’s inflation goal. Nevertheless, a number of Fed officials have voiced doubt over the sustainability of the stronger inflation figures.

Not only that, but is the inflation “sticky?” How resistant to price changes is an item? “Flexible” items include new and used cars, clothing and hotel rooms, and items with “stickier” prices include housing, insurance, medical care and food purchased at restaurants. Flexible items ex-food and energy have risen at a faster clip than core sticky items in the three months ending in March.

What does this mean for Optimal Blue’s clients? Inflation, regardless of how it is measured, is not an overwhelming concern of the market. It is, however, something to keep in the back of our minds, knowing that an unexpected uptick in inflation could move rates higher. But we aren’t there yet.

Catchy credit card ad copy aside, net worth is of paramount importance to many people – including Optimal Blue’s clients. Although the Fed’s actions tend to follow the markets rather than set the course for long-term interest rates, certainly what the Fed does impacts interest rates. But does the Fed impact household net worth? And if not, should it? And if a borrower’s net worth is increasing, shouldn’t that help business for OB’s clients?

Let’s take a quick look at general trends in household net worth relative to Fed policy. In a world where populations are steadily aging, the ability to work and produce income is arguably declining. Older people tend to look at net worth rather than income. So household net worth is growing increasingly important for populations at large, as an eventual means of meeting various living expenses. Think reverse mortgages for those 62 years or older. From this perspective, policymakers across the globe would do well to help households grow, or at least preserve, net worth.

The Fed, however, does not have instructions on helping net worth. It is more focused on maximizing employment and maintaining price stability. Granted, doing that can lead to greater net worth in some households. And there are some analysts who believe that household net worth optimization (stability, growth) would appear to be a reasonable, if unstated, mandate for the Fed. The March FOMC minutes, which indicated that “a cautious approach to raising rates would be prudent,” seemed to support the idea that asset price stability (i.e., household net worth preservation) is at least implicitly part of the Fed’s decision process.

A longer term examination of household net worth trends suggests the Fed has frequently reacted to extremes in net worth growth rates, tightening when the rate was too high and easing when it was too low. The longer term perspective also provides some insight into the latest tightening cycle. It indicates that it made sense for the Fed to begin tapering its QE purchases in early 2014, when net worth growth was extremely high, but that raising rates this past December, when growth was sharply lower, seems to have been fairly risky. Moreover, given the collapse in asset prices at the start of 2016, the net worth data suggest it would have been a colossal error to raise rates again in March. Going forward, given the fragility that lingers from Q1, continued “caution” by the Fed indeed seems “prudent.”

Every experienced LO knows that the ratio of household net worth to disposable income factors into the underwriting decision, if only subconsciously. How does a borrower have a high net worth and no income? The net worth-income data encapsulate the Fed’s quandary, showing both why it might want to tighten policy and why it cannot tighten: asset values are at dangerous extremes relative to incomes. But the weak income story is precisely why the Fed needs to preserve or grow asset values – and refrain from excessive tightening. Once again, the Fed seems stuck in the middle.

And plenty of OB’s clients lend in areas where home price appreciation is steadily going up. The home equity net worth data show a more balanced and moderate picture for housing relative to other financial assets such as the stock market. The modest gains in home equity net worth is consistent with some analysts believing that mortgage credit is a relatively cheap asset class. So perhaps property values will continue to increase, therefore increasing the net worth of owners. But be careful about wishing for a good thing: the industry needs first-time home buyers who aren’t priced out of the market.

Optimal Blue clients are continuing to originate loans that are not fixed, and that fit a particular borrower better. The adjustable rate mortgage (ARM) earned a bad rap after the 2006 housing crisis. The problem was, before the crisis, many borrowers were able to qualify for more home than they could actually afford by using interest-only, No Income Verification or No Ratio ARM products. When the housing market tanked and many houses lost value, some homeowners with rising mortgage payments either foreclosed or walked away from their properties. Suddenly those programs became the focal point of government intervention – but…

Many of those programs provide valuable financing for our client’s borrowers. Fast forward 10 years to today. The ARM is back to show potential homebuyers it’s not the villain of the housing market. Some ARM programs are very stable and are a good option while the Fed raises short term rates.

Some don’t believe that, however. This myth stems back to the days of the 2008 recession. All ARM loans have annual and lifetime caps, so there’s built in protection. If stability is what a borrower is concerned with, they should consider an ARM with a longer adjustment period. For example, Navy Federal Credit Union’s 5/5 ARM adjusts only once over the initial 10-year period.

OB’s clients know that interest rates rise and fall in cycles. Even if rates are increasing now, that doesn’t mean they won’t be on the downturn at the next potential adjustment point. Many ARM mortgage holders never refinance to a fixed rate because the many ups and downs of the market happen in-between their adjustment points. Refinancing is always an option for those with ARMs. OB clients help their borrowers calculate closing costs on the loan to make sure there is an improvement. Research and the guidance of a trusted lender will be the winning combo for saving money over the life of the mortgage.

Adjustable rate mortgages are not only for folks who want to be in a home for a few years. ARMs have fixed intro periods that can vary from one to even 15 years. If a borrower thinks they’ll own that home for five or six years, a fixed mortgage rate may have a higher interest rate over that span. So why spend the extra money associated for the added security of a fixed rate? Again, it pays to plan for various scenarios based on how long the borrower plans to own the home.

The term “adjustable” gives the misconception ARMs are unstable. The ARM is very similar to a fixed-rate mortgage; both offer a 30-year term with no prepayment penalty and early payoff options, among other similarities.

The intro rate period (usually a lower rate) and potential rate changes (up or down) over the life of the loan is what makes an ARM unique. Optimal Blue’s clients stress that borrowers should knowing their cap and what the difference in payments are over the life of the loan. These protect borrowers, even if rates are on a roller coaster. Knowledge is power as an ARM holder. That “power” helps borrowers make necessary calculations to figure out a yearly breakeven point should their interest rate increase and the introductory rate savings begin to decrease.

Optimal Blue’s clients encourage their LOs to help their borrowers in researching loan options before closing. Often when one adds up the ARM’s initial savings plus the cost to refinance, an ARM is hard to beat from a financial standpoint – it is definitely a value-add for lenders.

All of Optimal Blue’s clients know that reliable lending decisions use an analysis of things like collateral and credit. But originators and underwriters will often point out that, in the credit decision, relying upon one number (the credit score) may not be accurate. A borrower’s credit score, whether from TransUnion, Experian or Fair Isaacson Corporation (FICO), can make the difference between owning a home and renting. It can also cost (or save) borrowers tens of thousands of dollars on interest since lenders set rates to reflect the quality of one’s credit score.

The algorithms behind the creation of a credit score are not static, however, and are updated from time to time. As credit reporting companies have improved and updated their models to reflect how consumers use their credit, Fannie and Freddie have been slow to “come about,” in part because of the difficulty and cost of changing their automated underwriting programs.

For example, Fannie balked at using the newest model, FICO Score 9, which was introduced 2014 and provides fairer treatment for those consumers whose scores have been lowered by medical bill collection accounts in their credit files or who have files with scant information because they make little or no use of the traditional banking system. According to Fair Isaacson, which owns FICO, applicants whose only major negatives are medical collections stand to see their FICO scores improve by a median 25 points.

But pressure has increased on Freddie and Fannie to modernize their credit standards, both from Congress and a directive from the FHFA (the federal agency that oversees Fannie and Freddie). In late June Fannie Mae will begin incorporating “trended credit data” into its automated underwriting platform. No longer will OB clients and other lenders be limited to making an approval decision on the basis of a single score.

Trended credit data will enhance the static snapshot of a consumer’s credit balances with 24 months of historical data, such as payment and balance. It will help OB’s clients examine and consider how consumers are managing their credit accounts over time. Today, lenders can see consumers’ existing balances on accounts and whether they have paid their bills on time; however, they cannot tell if consumers are consistently carrying debt loads on revolving accounts such as credit cards, or whether they pay their balances in full every month.

For example, a consumer with a large credit card balance who pays it off in full every month could be a better credit risk than a consumer with a large credit card balance who makes only the minimum payment each month. And for consumers who don’t have a large amount of available credit, but pay their balances every month, trended credit data may help originators determine if they are a good credit risk and better their ability to obtain a mortgage loan. Trended credit data should help consumers who don’t have a large amount of available credit, but pay their balances every month, for example.

Legislation was introduced late last year by members of the House Banking Committee that would require federal regulators and the GSEs to adopt alternatives to FICO that are more inclusive and updated models that incorporate non-banking forms of credit, such as rent, utilities, and cellphone payments to supplement a standard credit file.

If passed, the legislation would allow lenders to use scores from FICO’s competitor, VantageScore, which claims it can provide scores on as many as 35 million consumers, many of whom didn’t have enough credit history to have a score. Many are young, just starting out in their careers. Disproportionately, they are minorities.

Last week we discussed how mortgage rates are set. Namely, not by the Federal Reserve, but by supply and demand. If no one wants to borrow money at a certain rate, then rates must drop to attract more borrowers. Conversely if the demand for capital is high, rates will increase if capital is scarce. The same can be said for those offering money to be borrowed.

That being said, what have made headlines recently are negative interest rates. What are those? Europe has turned into the proverbial black sheep of the family; like the cousin most families have, who’s been unemployed for the past two decades, shows up to events he wasn’t invited to, eats all the shrimp appetizers, then asks to borrow $20 bucks on his way out the door.

Nine out of the ten G10 central banks (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, and the U.K.) are priced to cut rates this year, by an average of 25 basis points (BP). The two-tier deposit rate framework could open the door for even lower rates, which is expected to push its deposit rate deeper into negative territory, to minus 40 bps. The aim of course is to head off deflation. Deflation is a general decline in prices, often caused by a reduction in the supply of money or credit. It can also be caused by a decrease in government, personal or investment spending. Deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

In case you’re wondering what happens to deposits in negative interest rate environments, you have to let go of conventional wisdom and enter the world of string theory and black holes, where common laws of nature fall apart, and fail to work. An interest rate below zero means that European banks are paying the central bank to hold their reserves, rather than earning interest on those reserves. If the negative interest rates were applied to customer deposits at banks, then customers would actually pay the banks to park cash in bank accounts, rather than earning interest on those deposits. I’m not sure where all the “Occupy Wall Street” people went, but it would be interesting to get their take on it.

Negative central bank rates attempt to accomplish what a traditional lowering of Fed Funds attempts to accomplish, that is to encourage business investment and consumer spending; increase the value of the stock market and other risky assets; lower the value of a country’s currency, making exporters more competitive; and create expectations of higher future inflation, which can induce people to spend.

Would the United States ever experience negative interest rates? Probably not. A few years back if you recall, Fed Funds was close to zero after being slashed six times alone in 2008. The Federal Reserve may have chosen to head into negative territory (which may have violated the US Federal Reserve Act) but opted for a few rounds, or three, of Quantitative Easing.

So while negative interest rates are fascinating to discuss, the likelihood of them happening here is very small. And the impact on mortgage rates is muted even further. Every one of OB’s clients knows that different borrowers have different credit profiles, different states have different foreclosure laws, and different investors have different underwriting criteria. There are exceptions, but it generally perceived that the credit risk of an individual borrower is much greater than that of a government. Therefore mortgage rates will always be above government debt.

Plenty of Optimal Blue clients have spent time staring at agency trading screens on Bloomberg or Reuters over the last few years. If you have, chances are you were either pricing loans, selling loans, or hedging loans. Chances are also pretty good that you noticed volumes in one of the most liquid markets in the world, agency mortgage backed securities (MBS), starting to flatten out. This is an important event, as any significant deterioration in the liquidity of the MBS market could lead investors to demand premiums for transacting in this market, which would ultimately raise borrowing costs for U.S. homeowners.

A little bit of context. An interesting characteristic of MBS trading is the existence of a forwards market which is known to some as: to-be-announced, or “TBA“. Where a pool of loans is being securitized the counterparties know the composite makeup of the mortgage backed security. In the TBA markets, however, these counterparties do not specify which particular securities will be delivered to the buyer on settlement day. Instead, they agree on a few basic characteristics of the securities to be delivered, which include the coupon rate, issuer, term, and face value. Thus, while the agency MBS market comprises over one million heterogeneous MBS pools, more than 90 percent of trading is concentrated in only a small number of liquid forward contracts. Why is this important to OB clients? If your secondary marketing department sells loans on a mandatory basis, chances are they hedge a good portion of the bank’s pipeline with agency TBA forward sales. These short sales of TBA MBS, which mitigate short term interest rate risk, are traditionally bought back before established delivery dates once loans have been committed to investors. Disturbances in liquidity, in any market, traditionally widen the bid-to-ask spread between sellers and buyers driving up transactional costs.

The depth of the TBA market has allowed for a highly liquid market to evolve. This market is used as a conduit to hedge new mortgage production, existing mortgage positions; for pricing new mortgages, and for speculating on the course of interest rates. All of these activities have made trading volumes in agency MBS much higher than that of corporate bonds. How high? According to the Securities Industry and Financial Markets Association, in 2015, agency MBS trading volume averaged approximately $190 billion a day, compared with $27 billion a day for corporate bonds.

What are the drivers of liquidity in the MBS market? There are a few. The first is the gross issuance of agency mortgage backed securities – many of which are issued by OB clients. MBS fluctuates substantially, usually with the level of long-term interest rates, a main determinant of mortgage refinancing. In 2013 when long-term interest rates rose sharply, gross issuance plunged almost 70%. The second important driver of liquidity in the MBA market is security ownership. Currently, out of the more than $6 trillion in agency MBS outstanding, investors in the market include: public institutions, banks, foreign investors, and mutual and pension funds. As most know, the single largest holder of MBS is the Federal Reserve, which has purchased agency MBS in implementing monetary policy to achieve the Federal Open Market Committee’s dual mandate of maximum employment and price stability. The Fed writes, “Agency MBS purchases help achieve this mandate by putting downward pressure on longer-term interest rates, supporting mortgage markets, and helping to make broader financial conditions more accommodative.” While that may be correct, the Fed’s buy-and-hold strategy certainly affects liquidity in the marketplace too.

Trade size, trading volumes and turnover rate (which is total trading volume as a percentage of total agency MBS outstanding) indicate a decline in market liquidity. Causes certainly include increased regulation, which has made it more costly for financial institutions to take on risk; a rise in agency MBS ownership among buy-and-hold investors; and a decline in issuance. However, measures of transaction costs and price impact suggest that liquidity conditions have been relatively stable since 2011.

Optimal Blue’s clients often wonder what happens to their loans after they close. More specifically, they often understand who services the loan – whether their company keeps (“retains”) the servicing or if it is sold to a bank or non-bank servicing company. But what about the actual asset? After all, someone actually owns the “bond” – the interest payments made by borrowers after the loan funds. Who owns those – is it Fannie Mae and Freddie Mac? Some insurance company or pension fund? Perhaps a money manager overseas?

It turns out that all of those can be investors in residential securities backed by mortgages. But OB clients should know that depository banks like Bank of America, Wells Fargo, Citi, and Chase are owners of huge sums of residential MBS, and those figures are open to the public. And these include agency MBS, non-agency MBS, jumbo whole loan pools, and so on.

The National Information Center recently released consolidated financial statements for bank holding companies for the 4th quarter of 2015. Although the information is not as comprehensive as the Quarterly Banking Profile (which also includes savings institutions), which is soon to be released by the FDIC, they provide a good early estimate of changes in bank assets and liabilities.

Agency MBS holdings increased by $52.5 billion for the top 50 banks (ranked by assets) in their “hold to maturity” (HTM) and “assets for sale” (AFS) portfolios during the fourth quarter. Similar to the previous quarter in 2015, demand was strong for conventional and GNMA pass-through securities. Conventional pass-through (PT) security holdings, primarily made up of loans underwritten to Fannie Mae and Freddie Mac guidelines, went up by $17.3 billion, while GNMA PT holdings rose $33.5 billion. Demand was weak for agency CMOs with holdings increasing only by $1.7 billion.

Digging into the numbers reveals some interesting changes. For example, the significant increase in GNMA PT holdings is driven by Bank of America Corporation whose GNMA PT holdings in AFS and HTM portfolio went up by $31.4 billion. Considering the $9.7 billion decline in agency MBS trading assets in Q4, however, it appears the increase was partially driven by classification change. Excluding trading assets, Bank of America Corporation’s agency MBS holdings increased by $39.9 billion. Wells Fargo & Company and Citigroup Inc. added $2.6 billion and $2.9 billion, respectively, to their agency MBS holdings. HSBC North America Holdings Inc. reduced its agency MBS holdings by $1.48 billion.

Holdings of non-agency MBS of the top 50 banks decreased $14 billion, while commercial MBS (CMBS) holdings rose $5.3 billion. Treasury holdings increased $21.5 billion, while agency debt holdings fell $4.8 billion from the previous quarter.

Overall, the allocation of bank portfolios to securities increased $28.8 billion over the quarter. Of most interest to OB clients, in the loan books one- to four-family first-lien residential loans increased $24.9 billion quarter over quarter.

So what does all of that mean? Banks have struggled for several years now finding commercial loans to put on their books. A likely replacement is securities backed by the U.S. Government in the form of Ginnie, Fannie, and Freddie mortgages. And this is indeed what is happening: the yield on these securities is better than the alternatives. And as long as demand is strong for them, and the supply level, it pushes prices up and helps to keep rates low for OB’s client’s borrowers.

Optimal Blue’s clients are filled with loan officers. And every loan officer out there who is worth their salt is talking to borrowers about affordability. And in many cases, helping them to make the decision of whether or not the client should keep renting or to make the move into home ownership.

Axiometrics Analytics found America’s most affordable and least affordable rent markets by analyzing 28 metro areas to better understand where rents are more affordable and may be most affordable in the future. The analysis reviewed rents to income ratios, looking at 30 percent or more of income spent on rent as unaffordable, with Little Rock, Salt Lake City, Las Vegas and Indianapolis ranked as some of the most affordable cities to live in. New York, Los Angeles, San Francisco, Miami and Oakland all ranked as the cities that are least affordable.

Interestingly enough, New York was the least affordable city in 2001, where rent averaged $2,300, while Little Rock was one of the more affordable places to live in 2001, with rent averaging $617, with a rent-to-income ratio of 17.4 percent, whereas the national average reached 27.7 percent. This was during the time of the early 2000 recession and New York job growth was negative 2.7 percent. Over the past 20 years, the best place to rent has been Indianapolis in 2007, where monthly rent was $701, equating to 15.2 percent of income going towards rent.

On the flip side, New Yorkers had a rent-to-household income ratio of 64 percent during this same time period, and the national average was 24.9 percent. New York will remain the least affordable place to live as the expected amount of income that goes towards rent is 50.5 percent, and Los Angeles is expected to become less affordable as rent starts inching towards 48.6 percent of households’ incomes. Little Rock will remain as one of the more affordable places to live in the near future, along with Salt Lake City, Phoenix, Albuquerque, Kansas City and Indianapolis. Other cities that expect to see rent decline include Houston, TX, Miami, FL, Phoenix, AZ and Albuquerque, NM.

What does this mean of OB clients? Taking an extreme look at things, if a potential home buyer is paying $10,000 a month in rent but could buy a home and have a $3,000 a month housing payment that is tax deductible, then it is an easy decision. It is an easy decision IF the client has the money for a down payment – which brings us to the down payment issue.

In some news this week Bank of America announced a 3% down payment program which circumvents FHA. (The program was anticipated, especially as the large banks and nonbanks have been forced to pay large settlements with FHA.) The program has no mortgage insurance, and is backed by a partnership with Freddie Mac and the Self-Help Fund, a non-profit company located in North Carolina.

After making the loan Bank of America sells it to Self-Help which in turn sells the loan to Freddie Mac. At this point BofA has capped annual volume at $500 million – not much when one considers that is about $45 million a month spread out over 50 states.

Still, this is exactly the type of thing that Optimal Blue clients and the industry will see this year: more innovation and programs that don’t fall into the strict government-sponsored lending programs that currently have the lion’s share of business.

The good news is that rates are low and moving lower. The bad news is that the economy is heading south and borrower psychology is worsening.

The “flight to quality” theme has continued all week with equity markets around the world going down. Of course this has created investor demand for the safe haven of treasuries as well as agency mortgage-backed securities. Global concerns continue to weigh on markets as earnings misses from European financial institutions are viewed as potential foreshadowing, and the press is consumed with the chaos overseas impacting our markets here in the United States.

Yes our markets are being moved by what is happening outside of our country. The Hang Seng Index having its worst annual start since 1994, and European markets are reaching their lowest levels since October of 2013. Adding fuel to the “Fear factor” Gold is trading beyond $1,200 an ounce and the price of oil continues to weigh on the markets: oil at $26 per barrel impact jobs and refining here in the United States.

Unfortunately the markets are not happy with Fed Chair Janet Yellen’s testimony on the state of the Fed’s thinking about the economy. In testimony in front of Congress Fed Chair Janet Yellen spoke of tightening financial conditions and uncertainty posing a threat to the US recovery. Recent market activity would likely delay the timeline for additional rate hikes this year, but for the most part she maintained her stance on additional hikes being “data dependent”.

The fixed-income markets around the world, as well as stock markets, are focused on two things: negative central bank rates and bad bank headlines. The Financial Times reports negatively yielding debt globally now exceeds $5 trillion, as central banks struggle to drive more economic growth abroad. The
Riksbank dropped its rate further into neg. territory and SocGen put up bad earnings/guidance. The combination of those two events, coupled w/very fragile sentiment, extreme risk aversion (a function of enormous P&L destruction YTD), and Janet Yellen’s testimony are creating a huge global nightmare.

And let’s not forget China – which is basically closed this week due to its New Year’s holiday. So some of the worst carnage in months is occurring while China is shut and the yuan has been rallying.

Returning to “negative” rates – it can’t be overstated how detrimental negative rates are for the markets. Depositors are basically paying the bank to keep their money there, and on the sidelines away from investment. Negative rates around the world are destroying bank stocks and in turn killing the market. Negative rates appear to be the preferred policy choice of central banks and this has played a key role in crushing bank stocks over the last several weeks. And of course many OB clients sell their loans to banks.

So we have “fast money investors” selling bank stocks. There is anxiety about the China yuan. There is sovereign wealth fund selling. We have decreasing expectations about growth in this country, and weak global demand.

Optimal Blue’s clients, however, are seeing yet another refi market in the offing. Most investors are dreading having their MBS portfolio potentially prepay, and thus MBS prices are lagging in the rally. Capital market’s staffs are dealing with margin calls due to the huge rally in MBS and on the flip side holding their pipelines while originators trying to renegotiate loans. Yes, at some point recent borrowers overcome the hassle cost of refinancing and investors see an increase in early pay-offs.

But is the pain worth the gain? Time will tell as plenty of potential borrowers for OB clients grow concerned about their individual balance sheets are fear more problems are ahead.

Optimal Blue’s clients are noticing that a large portion of aging boomers are choosing to downsize and live in housing communities but that millennials prefer the flexibility of renting over owning. We’re also seeing gross underemployment (some folks working 2-3 jobs) creating economic barriers to potential buyers and that stagnant wages haven’t kept pace with inflation. And thus we are witnessing the American consumer demanding more multifamily dwellings.

According to the National Association of Home Builders, multifamily starts, at the end of 3Q15, were at a decade long high with 425,000 starts. So, where do all the cash flows from this sector end up? In mortgage backed securities, specifically Multi-Family Mortgage Backed Securities (MF MBS), and the agencies have an integral part in the process. FNMA, FHLMC, and GNMA makeup a large portion of the $1trillion secondary market for these products with market shares of 26%, 24%, and 10%, respectively (other market participants include CMBS, banks/thrifts, life insurance companies, and state/local Agencies).

Though most of OB’s clients focus on lending for single family homes and units, it is helpful to know that multifamily loans are made to borrowers under varying terms, such 10 years, 7 years, fixed-rate, adjustable-rate, full or partial interest only periods. During the life of a multifamily loan, the balance is generally amortized over an amortization term that is significantly longer than the term of the loan. As a result, there is little amortization of principal, resulting in a balloon payment at maturity. The borrower usually repays the loan in monthly installments that may include only interest for the entire term of the loan, only interest for a portion of the term and then both principal and interest, or principal and interest for the entire term of the loan.

And just like the vast majority of loans on single family loans, multi-family loans are put into securities and sold in the secondary markets. MF MBS are often issued with prepayment penalties that protect the investor in case of voluntary repayment by the borrower. These prepayment protections are most frequently in the form of lockout periods, defeasance, prepayment penalties or yield maintenance charges.

(Lockout periods…a prepayment lockout is a contractual agreement that prohibits any voluntary prepayments during a specified period of time, the lockout period. After the lockout period, some instruments offer call protection in the form of prepayment penalties. Defeasance: With defeasance, rather than loan repayment, the borrower provides sufficient funds for the servicer to invest in a portfolio of Treasury securities that replicates the cash flows that would exist in the absence of prepayments. Prepayment Penalty: Prepayment penalty points are predetermined penalties that must be paid by the borrower if the borrower wishes to refinance. Yield Maintenance Charges: A yield maintenance charge is the most common form of prepayment protection for multifamily loans/securitizations. It is basically a repayment premium that allows investors to attain the same yield as if the borrower made all scheduled mortgage payments until the maturity of the security. Yield maintenance charges are designed to discourage the borrower from voluntarily prepaying the mortgage note. The yield maintenance charge, also called the make-whole charge, makes it uneconomical to refinance solely to get a lower mortgage rate.)

Much of this doesn’t make sense for OB’s clients on the single family side of thing. But loan servicing is pretty straight forward and very similar to what our clients do for home loans. The mortgage bank or a third party may service multifamily loans going into an agency MF MBS. The master servicer is responsible for day-to-day loan servicing practices including collecting loan payments, managing escrow accounts, analyzing financial statements inspecting collateral and reviewing borrower consent requests. All non-performing mortgages are usually sent to the special servicer. The special servicer is responsible for performing customary work-out related duties including extending maturity dates, restructuring mortgages, appointing receivers, foreclosing the lender’s interest in a secured property, managing the foreclosed real estate and selling the real estate.

So although related there are enough differences between home loans and the process for multi-family that make them “cousins” rather than “siblings.”

The mortgage industry is nearly fourth months into the wave of the future known as TRID. Ultimately Optimal Blue clients are asking, “Will the new regulations actually benefit the borrower?”

For the last 30 years, mortgage lenders relied heavily on 2 documents in an effort to cover the nitty gritty details of a transaction. The Good Faith Estimate (GFE) detailed anticipated closing costs to borrowers. And the Truth In Lending Disclosure (TIL) was designed to indicate the Annual Percentage Rate (APR) of the loan. Albeit comforting to have the familiarity of the old-school forms, in truth, both disclosures were difficult for consumers to understand, creating confusion regarding the ultimate closing costs and actual interest rate of the loan – thus the onset of TRID as we know it.

OB clients know that the CFPB’s goal was to improve accuracy and simplify the information for the borrowers benefit. In addition, the Hud-1 settlement statement was also revamped as the numbers did not always match up with the GFE and TIL. Thus the GFE and the TIL have been replaced by a single disclosure, the loan Estimate designed to make it easier for borrowers to understand the key terms, costs and risks of a mortgage loan earlier in the process.

In order to protect the borrower, there can be no variations in fees charged by the lender as stated on the Loan Estimate. In addition, third party fees are held to a ten percent variation between the Loan Estimate and those reflected on the Closing Disclosure. The only charges exempt from the ten percent cap is any service the borrower can actually control and choose such as homeowner insurance.

One key issue with the new rules is the interpretation of the required time-lines by lenders. Understandably cautious, most lenders are now quoting 45-60 days for loan closing compared to 30 days pre-TRID. Also, with the new rules it’s critical that all parties involved work closely together to keep the loan on track. The expiration of interest rate locks is of particular concern as any change to the loan or closing figures after a Closing Disclosure is issued will necessitate the issuance of a new Closing Disclosure and an additional three business day waiting period. Extension fees are expensive especially with interest rates on the rise.

These changes may seem difficult now but as time passes and issues are ironed-out, mortgage industry folks will rally and conquer beast known as TRID. But it is not a fast process. After it jumped up by three full days in November the average time to close a first mortgage loan stabilized in December at 49 days. The November increase had been attributed to unfamiliarity with the new Truth in Lending Disclosure Rule for applications received after October 3.

Ellie Mae’s Origination Insight Report showed that purchase mortgage closings did take one day longer, 50 days, to close in December but that was offset by a drop in closing times for refinances from 49 to 47 days. The average time to close FHA and conventional loans remained largely unchanged at 49 days, while for VA loans it increased from 50 to 52 days.

And it did impact the financial results of mortgage originators. Most of the large lenders & investors have now reported 4Q15 results. Mortgage banking revenues were down Q/Q as lower volumes were coupled with lower gain-on-sale margins. Some smaller companies have noted that the new TRID disclosures have slowed mortgage volumes.

And it doesn’t stop with investors. For example, title insurers’ earnings have been impacted. While some analysts believe that TRID has been manageable for large mortgage and title companies, it is obvious that it has led to some delays in closing loans across the industry. For title insurers, this will likely result in lower title margins, since revenue is recognized at close.

OB clients know that we will get through this as an industry. But is the consumer truly better off when the mortgage and related industries’ results are negatively impacted, and those costs are passed along?

Without the secondary market Optimal Blue’s clients, and practically any lender, would find themselves “full” of loans in a hurry. It is important for loan originators to realize that the secondary markets provide a pricing mechanism for loans as well as an outlet for the assets, allowing lenders to obtain capital to lend again. Generally speaking investors agree to buy a loan in the future, after it is locked with the borrower and then funds later. What happens when this mechanism breaks down?

Recently, the NY Federal Reserve released a report which studied the recent rise, and net effects of “settlement fails.” A settlement fail occurs, and is recorded, when a market participant is unable to make delivery of a security to complete a transaction. Such a “failure to deliver” can result from the outright sale of a security, or the initiation or termination of a transaction to borrow or lend a security. The party to whom the delivery was due will also record a fail, in the form of a “failure to receive.”

As these “failure to delivers” rarely garner much attention outside the back offices of banks and security firms, this relatively obscure statistic rarely makes the news. Settlement fails, however, are a particular issue for the world’s repo markets, where banks borrow trillions of dollars each day through pledges to sell securities such as US Treasuries or mortgage debt in return for cash, and then “repurchase” these assets back at a later date. Under repo agreements, markets typically see large banks sell a portfolio of, say US government bonds worth millions of dollars, with a promise to buy the portfolio back at a predetermined date. Under these conditions, the initial buyer of the securities, in essence, acts as a lender to the seller. A “fail to deliver” can happen if the seller does not hand over the assets to the purchaser in the agreed time frame, or vice versa. This occurrence may sound like a form of market failure, but it is a relatively regular market occurrence. Why? Historically, before the implementation of a fails-charge, it was used as a form of cheap finance.

Even though settlement fails may be common, it’s easy to see that that they can create liquidity problems for OB clients and other market participants, as well as raising operational and counterparty credit risks. Between the time a trade is negotiated and the time it is settled, counterparties can be exposed to such risks. Settlement fails can exacerbate such risks because prices will tend to deviate further and further from agreed-upon transaction prices as time passes. The extent of risk buildup depends on a number of characteristics of the fails, including the duration of the fail, concentration of fails by security, and the price sensitivity of the securities that have failed to settle.

According to the Federal Reserve, aggregate Treasury security settlement fails have come down since June 2014 as the spike in fails of recently issued securities subsided. Nonetheless, fails in seasoned issues (defined as securities issued more than 180 days prior) continued their upward trend. The volume of settlement fails on any given day reflects the product of the number of issues failing and the average quantity failing per issue. So which of these factors does the increasing volume reflect? According to the Fed, both factors are in play. That is, the number of different seasoned issues failing has been rising over time and the average quantity of fails per issue has also been increasing.

Seasoned fails have been trending upward, and this increase can be explained by more issues failing and in larger quantities, but not by longer fails episodes. Moreover, the fails are increasingly dispersed across securities, with little apparent concentration in particular tenors or vintages of securities. Going forward, the continued growth in seasoned fails bears close watching, even as concerns are somewhat mitigated by the short tenure and wide dispersion of the fails.

As Optimal Blue’s clients know, mortgage pricing is a matter of supply and demand. So this week plenty of heads turned in the industry when the Federal Housing Finance Agency closed a loophole in its membership in its issuance of the final rule on captive insurers. And this will impact both the supply and demand for mortgages.

Remember that the FHFA is the entity that not only oversees Fannie Mae and Freddie Mac but also the Federal Home Loan Bank system. And companies were looking with great interest at the Federal Home Loan Bank (FHLB) system as a possible source of financing. But the announcement, in simple terms, states that the FHLB will be kicking captive insurers, and thus mortgage REITs (mREITS), out of the FHLB.

All is not lost, however, and these things take time to unwind. mREITs that joined prior to September 2014 will have a five-year sunset period. Those joining more recently will have a one-year sunset. Analysts were quick to point out, however, that regardless of timing that this is not good news for the mortgage REIT sector (and mortgage credit availability more broadly). Names that popped up immediately are well known to capital markets staff: Redwood Trust, Two Harbors, Annaly, and Invesco for example. Levering whole loans with advances is the only asset strategy that produces a return above their cost of capital.

Similar to the proposed rule, the final rule prohibits captives operating under the five-year sunset provision from either holding advances in excess of 40% of their assets or renewing existing advances beyond the sunset date.

The FHFA notes that 20 of the 25 captive insurance members with mortgage REIT parent companies gained access to the FHLB system after the proposed rule. “This trend has become a matter of growing concern to FHFA, as it has become increasingly clear that captives are being promoted and used as vehicles to provide access to Bank funding and to other benefits of membership for institutions that are legally ineligible for membership.” The FHFA continues by detailing a litany of structural and operational concerns with the admittance of captive insurers into the FHLB system including the potential for firms without significant housing operations to gain membership, the statutory contours of the Federal Home Loan Bank Act, and the “dramatic increase” in captive insurer membership applications.”

Analysts see FHLB membership as providing benefits to mREITs through funding diversity more than through lowered costs. But anyone hoping for good news in jumbo securitization was disappointed. The non-agency funding of jumbo whole loan conduits and floating rate commercial mortgage financing took a step back, and broker/dealer alternative financing vehicles will be more expensive for those products.

OB clients and other lenders saw FHLB advances as a possibility for the long-awaited possibility of accelerating the “return of private capital” back to the mortgage markets. In a FHA/VA, Freddie, Fannie world jumbo loans have taken a back seat, and the non-QM lending channel has not skyrocketed as some thought it would. Even in jumbo-land most of the loans are of pristine credit quality, and those are being held by banks in their portfolios especially with commercial lending opportunities not being terribly exciting or abundant.

And so where does this leave things for OB clients? As noted, the rule doesn’t take effect immediately so MREITs do have some time to adjust. But with everyone asking about the fabled “private market”, this news of the loss of a financing alternative hinders progress in that front. And that in turn, and in a roundabout way, impacts rate sheets – and not for the better.

It is a safe bet that most of the rank and file of Optimal Blue’s clients have provided their superiors with estimates of business for 2016. And it is also a safe bet that no one said their residential origination volume was going to decline. That would be heresy! But let’s take a look at what the “experts” are thinking for 2016 in terms of interest rates and the housing markets.

Let’s start with the potentially negative news first. One major downside risk is that there is more rapid slowing than expected in China. We saw this in the first week of the new year as China’s economy hit its stock markets, which in turn hurt ours. As one would expect, however, our bond market rallied/improved because of it.

The second potential issue could be the deteriorating American manufacturing sector which is now in recession. If an economy slows, of course, it would lead to lower rates since the demand for capital is less: no one wants to borrow money! Unfortunately if potential home buyers have no jobs that is an even greater problem.

Another fear is of that problems in the Middle East escalate and plague the entire world. Lately the issues between Iran and Iraq have boiled up, and ISIS continues to be a threat to stability.

Let’s turn to housing here in the United States. Many economists think we can expect the 30-year fixed-rate mortgage to average below 4.5 percent for 2016 on an annualized basis. That is indeed good news for OB’s clients. They know that gradually higher mortgage interest rates will present an affordability challenge – but once again if the rate move is due to a strengthening labor market then borrowers will be in a better position to borrow to buy homes.

Most expect house price growth to moderate a bit to 4.4 percent in 2016 driven in part by the reduction in homebuyer affordability and reduced demand as a result of Fed tightening. And watch for housing activity to grow in 2016, despite monetary tightening, with both housing starts and building permits to improve once the weather becomes seasonally better.

Yes, the FOMC did raise the target fed funds rate range from 0.0%-0.25% to 0.25%-0.50%, citing “considerable improvement in the labor market conditions (in 2015).” They further stated they are reasonably confident that inflation will rise, over the medium term, to its 2% objective, and that monetary policy will remain accommodative after the increase supporting further improvement in the labor market and a return to 2% inflation. Many economists believe that the target federal funds rate will reach 1% by the fourth quarter of 2016. There is no perfect time to raise rates and markets will always get nervous, but the underlying health of the U.S. economy points to gradual rate increases over the course of the coming year.

In terms of residential volume, due to the strength of the economy most believe we’ll see an increase in the purchase market in 2016, despite gradually increasing rates. But the flip side is that mortgage origination volume will be slightly down next year due to a reduction in refinances.

The good news is that the Federal Reserve Board is seeing economic growth which should continue to keep the banks happy in terms of the fundamental economic conditions they’re lending to, as well as the equity investors that are looking for continued growth and strength in the economy to support the projects that they’re investing in.

Experienced Optimal Blue clients know that not everyone deserves a home loan. Often loan officers find problems with the collateral, with the borrower’s capacity to pay, and so on. And of course the borrower’s credit history is a primary focus in lending them money. We also know that politicians will often try to influence lenders, especially the agencies, to extend credit to borrowers whose credit is on the edge of what makes sense. So, as an industry, what are lenders seeing in terms of credit trends?

Many reports indicate that lenders appear to be raising the bar on minimally acceptable credit scores. And the number of mortgage quotes received by borrowers with less than ideal credit scores has not kept pace with the growth in quotes received by more ideal borrowers. For example, Zillow reports that for the first time since 2012 obtaining a mortgage today is harder than it was a year ago mostly because lenders are raising the bar on what they think is a minimally acceptable credit score.

Lenders are quick to point out, however, that though it has gotten modestly more difficult to get a mortgage compared to a year ago it remains far easier than during the depths of the recession in 2011. There are a few key factors driving the recent tightening in access to mortgage credit, most notably a shift upward in the minimally acceptable credit scores of successful mortgage applicants.

OB clients who have been around for a while remember that 10-15 years ago the minimally acceptable Fair Isaac credit score among the bottom 10 percent of successful applicants was 635. In the years following the collapse, as lenders drastically tightened standards, the minimally acceptable credit score generally rose above 700. It has dropped for the last few years but it appears to be on the rise again.

Other indicators monitor how many mortgage quotes potential borrowers receive, based on several variables submitted with their request for a quote, including their credit score. Lenders are showing a higher preference for safer borrowers with higher credit scores than they have in the recent past. Borrowers with FICO scores at the lower end of what is generally acceptable (600-640) have seen little change regarding the number of quotes they receive for mortgages.

Not all variables indicate a tightening in mortgage credit. What about the debt-to-income ratio? Qualified Mortgage (QM) rules have constricted DTI ratios in spite of experienced lenders knowing that high DTI borrowers may present a better risk to a lender than a lower DTI borrower when other factors are considered. A borrower’s DTI typically cannot exceed 45 percent (their debt payments cannot consume more than 45 percent of their income) in order to be eligible for a conventional loan backed by Fannie Mae or Freddie Mac. So it is no surprise that acceptable DTI ratios haven’t moved much, especially as non-QM lending has not skyrocketed.

What will Optimal Blue clients in 2016 see in terms of extending credit to marginal borrowers? There are plenty of “experts” that believe mortgage rates will increase next year. (How many times have we heard that?) Debt-to-income ratios may become a problem for borrowers if mortgage rates rise over the next year. More income will be needed to cover even marginally more expensive mortgage payments and those potential borrowers currently bumping up against the 45 percent DTI ceiling may be pushed across the threshold when considering these higher payments.

So while higher mortgage interest rates, if they come to pass, may not translate into big changes in monthly payments, they may help tighten the screws on those potential buyers looking to spend as much as possible on a home while still qualifying for a conventional loan.

With Fannie Mae and Freddie Mac buying the bulk of product from Optimal Blue’s clients, as well as that of the rest of the residential lending industry, what those two agencies do, and what they plan to do, is of paramount importance. So there were many interested parties who pored over the FHFA’s release of its 2016 scorecard for the GSEs and Common Securitization Solutions (CSS). Especially since it may impact rate sheets.

The new scorecard mandates that the government sponsored enterprises (GSEs) prepare for the expiration of HARP by creating a new high-LTV refinance program that will be implemented in January 2017. (Yes, over a year away – but these things take time.) They are also being instructed in implementing “Release 1” of the Single-Security Initiative in 2016. Freddie Mac will start to utilize the Common Securitization Platform (CSP) to perform activities related to its single-class, fixed-rate securities. No Single Securities will be issued under this phase of the program.

In 2018 we can expect to see “Release 2” of the Single-Security Initiative implemented. Both Fannie Mae and Freddie Mac will start to issue Single Securities and commingled re-securitizations.

“Frannie” is also expected to transfer the credit risk on at least 90% of the UPB of single-family mortgages acquired in 2016 for 30y fixed-rate, non-HARP loans with LTVs greater than 60% (so-called “targeted loans”) and explore ways to transfer credit risk on other types of single-family mortgages outside of this “targeted loans” category. Along those lines Freddie & Fannie will explore ways to expand the investor base for credit-risk transfer transactions.

In a nod toward politicians who believe that these agencies should help the consumer, the FHFA is requiring that the GSEs further increase access to credit for borrowers by removing impediments that may be preventing qualified borrowers from obtaining a loan. Supporting this objective, the GSEs are to enhance their rep and warranty frameworks by completing an independent dispute resolution process for lenders who do not believe that their loans have breached the GSEs’ rep and warranty policies, as well as provide lenders with feedback on the quality of their loan originations shortly after the loans have been sold to the GSEs.

Analysts were quick to point out that the new high-LTV refinance program will benefit certain borrowers. FHFA Director Mel Watt had already expressed his intention in May 2015 to let HARP expire at the end of 2016. The bi-partisan omnibus spending bill also contained a provision that would terminate the Making Home Affordable program (of which HARP is a component) at the end of next year, essentially sealing the fate of the long-dated program. It is possible that it will be open to some pre-HARP borrowers, effectively serving as an extension of HARP for this subset of homeowners.

It is also possible that OB clients see post-HARP borrowers able to use the new refinance program – especially borrowers who refinanced through HARP but may not yet qualify for a refinance under a full underwriting process, since this subset of borrowers would likely benefit the most from a new streamlined refinance process.

But capital markets folks were most interested in the single security news. “Release 1” is scheduled for 2016 and “Release 2” (the actual introduction of the Single Security) scheduled for 2018. The scorecard requires that the market be notified of the precise implementation date of the Single Security at least 12 months in advance so that stakeholders can prepare for the change. The FHFA will also develop a process to evaluate new or updated GSE policies that may affect prepayments and buyouts on TBA mortgages, as well as monitor issuance and prepayments between the two agencies to alleviate concerns by some investors that with the introduction of a Single Security and the ability to deliver either Freddie or Fannie pools into the same TBA deliverable.

The Federal Open Market Committee meeting is upon us. We’ve seen oil plummet in price, impacting both bond and stock markets. The residential lending industry is still grappling with the implementation of “Know Before You Owe.” So what might Optimal Blue’s clients expect regarding mortgage-backed securities heading into 2016?

First off, in spite of whatever the Fed does to short-term rates in the next few meetings, most expect that it will continue with its program of full reinvestment of pay-downs at least until the middle of 2016. It may scale these back toward the end of 2016 if its rate increases are having the desired impact. The agency MBS sector could gradually reset to a new range of spreads in anticipation of an end to Fed’s reinvestment program once the Fed starts the hiking cycle. When one looks at the historical spread between agency MBS and Treasury securities, current MBS spreads are currently about 25-30 basis points “tighter” than where they traded in the past.

Most estimates by the MBA, Fannie Mae, and Freddie Mac point to a similar residential loan volume for 2016 versus 2015. But what about “net” issuance, since investors are likely to replaced pools of loans being refinanced by other pools of newly issued securities? Although a portion of the recent pickup in net supply of agency MBS is simply because of the seasonality in the housing market, the outstanding balance of first-lien residential mortgage debt has been increasing again and many analysts expect the annual net issuance of agency MBS to be very high at about $185 billion going forward even if banks increase their mortgage loan holdings by $50 billion per year.

Mortgage originations are finite, and for all the market-share gyrations out there it is still expected to be about $1.2 trillion in 2016. As the volume of MBS available for relative value trading is limited, the short-term performance of MBS is likely to be strongly driven by the direction of interest rates and implied volatilities. If the economy weakens and rates rally such that servicers are forced to buy MBS, the lack of “true float” in the MBS market could cause a sharp tightening of spreads even from their current rich levels in the short term. One argument against that is if the economic outlook continues to improve and the rates market sells off, spreads are likely to widen in the short-term as carry offered by MBS worsens and no major investor group is likely to be interested in buying MBS at current spread levels.

We’ve talked about supply – but what about demand for MBS? Domestic bank holdings of agency MBS increased by about $115-120 billion and their residential mortgage loans increased by about $40 billion over the first ten months of 2015. The strong demand from domestic banks is one of the important reasons for why MBS spreads have remained very tight over the past several months, and it is hard for MBS spreads to materially widen as long as this demand source doesn’t go away. But once the Fed starts tightening the market will be entering an uncharted territory from bank demand perspective as there are several unknowns on how the drivers of bank demand will evolve. As domestic banks own close to 28% of all outstanding balance of agency MBS and that there is very limited float available in this market, their activity in the MBS market is going to have a decisive influence on the direction of MBS spreads in 2016.

There is also the question of demand by domestic money managers and mortgage REITs. The demand for MBS from this group, at least the money managers, has been very good in 2015. And overseas investors have provided a strong demand for MBS and were net buyers of about $74 billion agency MBS from 2H’14 to 1H’15. While a major portion of the net demand during this period came from China and Taiwan, more recently, China seems to have stepped away from the market while Japan has started adding agency MBS.

No one can predict the future with any certainty, especially the financial markets. Stock prices go up and down, sometimes randomly, as do interest rates. Certainty is hard to come by for investors, but for owners of securities backed by mortgages it is especially important. How long will they receive the monthly payments? How long until the borrower pays off the mortgage? These factors influence the price of a mortgage-backed security, thus impact the price that borrowers see on rate sheets. And so it is important for Optimal Blue’s clients to know what factors investors hone in on in determining prepayments.

There are sharp differences in the prepayments of new production high LTV collateral based on loan purpose. High LTV purchase loans when “in the money” (rates have dropped since the loan funded) have had relatively high prepayments. Much of this is due to the fact that these borrowers have undergone a full underwriting process, demonstrating their ability to qualify for a refinance under today’s stricter underwriting guidelines, and accrete additional incentive to refinance as their homes appreciate in value because of the possibility of lowering or eliminating their mortgage insurance premium.

In contrast, high LTV refinance loans have continued to exhibit strong “call protection” – they don’t pay off early. The bulk of these borrowers refinanced through the HARP program, which has very limited underwriting requirements, based only on recent pay history and verbal verification of employment. They have not demonstrated the ability to qualify under a full underwriting process. Furthermore, many of them would have to get additional mortgage insurance to refinance outside of the HARP program (borrowers can refinance through HARP only once), further dampening their economic incentive.

What about loans funded through broker or correspondent channels, also known as third-party originations? Generally speaking there is higher rate sensitivity for loans that have gone through a third-party origination channel. The magnitude of the TPO effect differs by loan age (it is most pronounced for loans that are 6-18 months old) and TPO channel (broker vs. correspondent). One of the explanations for the higher prepayments of broker and correspondent loans is that these borrowers tend to respond very aggressively to solicitation offers for lower rates. Many of them have refinanced several times with the same broker and respond to very small changes in rates.

Borrowers who have refinanced through a TPO channel are more likely to be serial refinancers. In contrast, the use of a TPO channel for the purchase of a home provides a less pronounced empirical signal about a borrower’s refinancing behavior. In other words TPO effects are largely limited to refinance loans. So if pools of loans contain large numbers of refinances originated through brokers, investors will be hesitant to purchase them at the same price as other pools.

What about FICO – does it influence prepayments? Recent prepayments for lower FICO collateral (i.e., FICO<700) have been higher than expected. Credit scores affect prepayments in the model in several ways. They affect borrower mortgage rates through LLPAs. They also affect the level of roll rates in the CDR model. However, their principal influence is on the level of refinancing activity predicted by the model. Higher-than-expected prepayments on lower FICO pools suggest that credit scores are less of a barrier to refinancing than assumed in the model. In addition to weakening the generic FICO effect, investors also look at the FICO effects for specific products. For example, conforming jumbo collateral has shown relatively modest refinancing impairment due to borrower FICO. Rather, the fact that they are jumbo borrowers seems to be a stronger credit signal than their credit score. So the impact seems less for the effect of FICO on the refinancing sensitivity of jumbo collateral. These factors and more are exactly the components that help make up the price an investor is willing to pay for a mortgage!

Optimal Blue’s clients are accustomed to politicians influencing the housing and mortgage markets, even if the particular politician’s influence is minor. The latest example of this occurred recently when former neurosurgeon and Republican-presidential hopeful Ben Carson suggested eliminating the mortgage interest deduction. Is it something for Optimal Blue’s clients to lose sleep over? No, but it is worth a discussion since eliminating the tax break pops up in the press occasionally, and most other countries don’t have a similar tax break yet their citizens still buy houses.

Other GOP candidates also support tax simplification by doing away with most itemized deductions. But they also expressly say they would retain the mortgage interest and charitable donation deductions. There is talk of a flat tax, fewer deductions. Wouldn’t it be nice if people could do their own taxes again? Carson has used 10% as his target tax rate, but when you reduce the rates that much (the current top rate is nearly 40%) you have to come up with the lost revenue somewhere. Doing away with deductions, mortgage interest and otherwise would help make up the U.S. Treasury shortfall.

The mortgage interest deduction is one of the most popular tax breaks in the system although it is a break that’s used disproportionately by wealthier taxpayers. Current law allows for interest on a loan up to $1 million to be deducted. Critics say that this makes the deduction basically a subsidy for oversized houses and encourages people to buy homes that are bigger than they really need or could afford without the write-off. But it also helps those who rely on the tax break and who need the deduction to help cover what they’re spending.

Over 70% of the deduction benefits go to the top 20 percent of income earners. The next 20 percent receive much of the rest—nearly 20 percent. Where does this leave the 60 percent of Americans who are on the middle and bottom rungs of the income ladder? They get a mere 9 percent of the benefits. In dollar terms, roughly $63 billion goes to the top 40 percent of income earners, while $1 billion goes to the bottom 40 percent.

The deduction for mortgage interest does not provide direct subsidies that help people with the initial purchase and associated costs. Rather, it subsidizes the ongoing debt associated with owning a home. Subsidizing debt can encourage people to take on more debt and buy bigger, more expensive homes, as mentioned above. So many believe that the mortgage interest deduction should be changed to limit current deductions and use the revenues to provide a credit for first-time homebuyers. Such a reform would be more progressive and would subsidize the home purchase, not the debt incurred. More efficiently and equitably promoting homeownership, and thus wealth building, can help more people get a toehold into the middle class and increase economic mobility.

The housing industry, and those trades it touches, is a unified and powerful front ready to vigorously defend the mortgage and other home-related tax breaks. The National Association of Realtors, the Mortgage Bankers Association, and other special interest groups have had great success in beating back previous tax reform proposals that also floated killing the home-loan interest deduction or replacing it with a tax credit. So although it is estimated that the deduction cost the country nearly $70 billion in 2013, the benefits to voters outweigh the cost. Given the political climate don’t look for any changes for at least several years, if at all.

The world’s economic community is abuzz with the news from last Friday. Namely, the employment data was strong, U.S. hiring swelled in October by the largest amount all year, and unemployment dropped to 5.0 percent, increasing the likelihood that the Federal Reserve will raise interest rates next month for the first time in a decade. It was a strong and balanced report. What are the numbers, and could they impact mortgage rates?

Federal Reserve Chair Janet Yellen turned heads recently when she reiterated that December’s Federal Open Market Committee meeting was very much “live” for a potential interest rate liftoff. Jobs numbers and wage growth had been particularly underwhelming in recent months, so few were terribly confident the domestic economy was ready to take off its low-interest training wheels just yet.

According to the Bureau of Labor Statistics the U.S. labor market added an astounding 271,000 jobs in October. That’s the single best month for job growth so far this year, and much better than what most analysts were expecting (somewhere between 180,000 and 185,000 job gains last month). The unemployment rate dropped to 5 percent – its lowest level since April 2008.

And so a December short-term rate liftoff doesn’t sound nearly as far-fetched as it did a few weeks ago. In fact even before Friday’s report, expectations for a Fed rate increase in December were building. Fed chief Janet Yellen and other top officials said this week that the economy is generally healthy and a move at next month’s meeting is a “live possibility.”

A sizeable portion of the mortgage workforce, which obviously includes Optimal Blue’s clients, has never seen a rate increase. The Fed cut the short-term rate it controls to a record low of nearly zero in December 2008 to try to stimulate growth during the recession.

The strong jobs report for October means the Federal Reserve may be weeks away from raising interest rates. Does that mean anything for mortgage rates? Perhaps not! The reason is that there’s an unprecedented shortfall in the safest assets, especially Treasury bills. And money managers that need risk-free assets, like funds that focus on government obligations that are most sensitive to changes in Fed policy, still need to keep buying them. The shortage means some key money-market rates will probably remain near historic lows even if the central bank increases its benchmark from near zero next month.

As a share of U.S. government debt, the amount of bills is the lowest since at least 1996, at about 10 percent, and the Treasury is just beginning to ramp up issuance of the securities after slashing it amid the debt-ceiling impasse. So the thinking is that the demand for high-quality short-term government debt securities is insatiable and there is just not enough supply.

And OB clients are reminded that short term rates aren’t the same as long term rates. The Federal Reserve, and the Federal Open Market Committee, does not control long term rates. Among the most well-known rates they set are overnight Fed Funds, the Prime Rate, and the Discount Rate. These are certainly not 15-year and 30-year mortgage rates. And that is what senior management is reminding their loan officer staffs. Analysts are talking about a flattening yield curve where short-term rates move higher and longer term rates remain relatively stable. And that would be good news for home buyers and those refinancing.

With all this talk about the Fed, more specifically the Federal Reserve Board, and whether or not it is going to change short term rates, a reminder is due OB clients about what the Fed actually does, and who does it, and how long they’ve been doing it. Optimal Blue clients should keep in mind that the Fed does plenty of other things besides voting on short-term interest rates. It looks at changes in margin rules, some banking penalties, the approval of banks, etc. – things that impact the strength and stability of the banking system in the United States.

The Federal Reserve System was founded by Congress in 1913 “to provide the nation with a safer, more flexible, and more stable monetary and financial system.” Over the years, its role in banking and the economy has expanded. In general the Federal Reserve’s duties fall into four general areas. “It conducts the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates. It supervises and regulates banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers. It maintains the stability of the financial system and containing systemic risk that may arise in financial markets. Lastly it provides financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system

The seven members of the Board of Governors are nominated by the President of the United States and confirmed by the U.S. Senate. There are only five now (Yellen, Fischer, Tarullo, Powell, and Brainard, with two vacancies). The Chairman and the Vice Chairman of the Board are named by the President from among the members and are confirmed by the Senate. They serve a term of four years. A member’s term on the Board is not affected by his or her status as Chairman or Vice Chairman.

Under the heading “Monetary Policy” the Fed has several tools at its disposal in order to “promote maximum employment, stable prices, and moderate long-term interest rates.” For example the fed sets the Federal Funds Rate. The Federal Funds Rate is the rate banks use to lend money to each other overnight, and it has been near zero for eight years in an attempt to stimulate our economy. If upcoming economic reports are strong, the Fed could still decide to raise the Fed Funds Rate at its December meeting. The key takeaway is that when the Fed Funds Rate does rise, home loan rates could follow suit, depending on overall market and economic conditions.

But are things picking up here in the U.S.? In housing news, the Commerce Department reported that New Home Sales fell 11.5 percent in September. The Northeast was the hardest hit with a near 62 percent decline from August. High demand, limited supply and increasing home prices influenced the drop. Despite the decline, year-over-year sales are up 2 percent.

Third quarter economic growth also slowed, according to the Bureau of Economic Analysis. Initial readings suggest Gross Domestic Product grew at a 1.5 percent pace in the third quarter, below expectations and well below the second quarter’s reading of 3.9 percent growth. After nearly $5 trillion dollars spent to help our economy since 2008, it seems to be stuck around 2 percent growth, much to the Fed’s dismay.

The Federal Open Market Committee doesn’t have a crystal ball in terms of rates, or events overseas that impact our economy. In fact critics say the Fed follows the markets rather than set the tone for the markets. And the bright side to the recent disappointing reports is that home loan rates remain near historic lows for OB’s clients and their borrowers. But it is good to know the Fed’s role in the economic machine when it eventually acts.

If money were no object would you rather rent something or own something? I’m sure most of you would say “own.” How about if money was an object, you needed what was most affordable? In terms of the housing market, in the majority of areas owning is more affordable than renting in the current housing market. According to a recent report by Goldman Sachs, however, owning is not as affordable as it looks, but renting is worse. What should Optimal Blue clients do with that information?

Goldman Sachs measures housing affordability in their Housing Affordability Index (HAI), which “takes into account a mortgage insurance premium and expectations about future income growth, suggests that housing is not as affordable as it looks for the marginal homebuyer. But because households have to live somewhere, the relevant question is how it compares with rental affordability.”

Instead of assuming that homebuyers can afford a 20% down payment, HAI measures based on marginal homebuyers who can afford a 5% down payments and have to pay a mortgage insurance premium. In addition, the HAI “recognizes that households make home-buying decisions not only on today’s income but also on their expectations of future income.” Goldman says that the HAI levels are around where they were in the mid-1990s. After all, a household has to live somewhere, whether it owns or rents the unit.

Even if buying a house is not as affordable as it looks, households may still decide to own if renting is even less affordable. As OB clients know, here is the main reason that renting is more expensive than owning: the rent to income ratio is high. Before 2000, renters spent 1/4th of their income on rent. In recent years that number has spiked to 1/3rd of income going towards rent. Rent has climbed by 30% from 1989 to 2013 while real income of renters has little changed during this entire period, which means that rent becomes less and less affordable.

“Although simple to calculate, the rent-to-income ratio among renters may be a misleading measure of rental affordability because of a number of mix shifts over time. First, as the homeownership rate increases, the remaining pool of renters may have lower incomes, leading to worse measured rental affordability. The decline in renter income from 2000 to 2005 may be partially related to the sharp rise in the homeownership rate during that period.” Most OB clients are familiar with “tiny houses” in areas such as San Francisco and Manhattan. Tiny houses are when families live in smaller than desired units because they cost significantly less.

To address the issues Goldman, “measured the rent and income of a fixed group over time. On income, we use the median household income among the 30-40 year olds, including both homeowners and renters. In this way, the income measure is not affected by the fluctuating homeownership rate. Moreover, this is the age when many people transition from renters to homeowners, so the rent vs. own decision is the most relevant to this age group.”

With all of the factors accounted for the rent to income ration can be used to measure affordability. We all remember the housing crash. During that time it was exponentially more affordable to rent rather than to buy. After the financial crisis is came back around for owners making the more economical choice. With the upcoming rate hike from the Fed people are worried that it will affect the housing market but Goldman Sachs says that it won’t have any affect and 2016 looks promising with owning remaining on top of affordability. And that bodes well for Optimal Blue clients!

Every once in a while someone will ask, “What happened to mortgage-backed securities?” First of all, they are alive and well. But are they being bought and sold, and is the pricing accurate? This last question is very important for Optimal Blue clients.

There is evidence that liquidity in fixed income markets, including the agency mortgage-backed securities (MBS) market, has declined since the housing market crisis and could pose risks to the financial system if left unaddressed. The “experts” say that this can be attributed to tougher regulation, specifically the requirement for financial services firms to hold more capital and reduce the amount of risk taken.

But not everyone agrees. For example, financial regulators argue that tighter regulations don’t impact mortgage origination volumes. So what are the recent trends in the agency MBS market? Agency MBS liquidity has declined since the crisis, yet remains at the pre-bubble levels of the early to mid-2000s. This this drop is driven by several factors, of which tighter regulation is one, but by no means the only one or even the primary one. The factors driving this decline, such as limited supply, an increase in all-cash buyers, or individuals paying off their mortgages, are unlikely to ease any time soon, suggesting current levels of liquidity are here to stay.

The “glory days” of 10 years ago where residential volumes zoomed above $2 trillion per year are gone. The euphoria in the run-up to the financial crisis, which was caused by ever-increasing house prices, investor complacency, weak capital requirements, inadequate oversight of financial firms, and unchecked leverage, led to a strong increase in demand for all asset classes, including agency mortgage-backed securities. The result was not only an asset price bubble, but also a “liquidity bubble,” which burst along with the asset price bubble.

If excessive risk-taking led to an increase in liquidity previously, then it should be no surprise that a reduction in risk will cause liquidity to decline. Part of this reduction in risk and liquidity is no doubt driven by tighter regulation, but it is also driven by an extraordinary shift in MBS ownership pattern as well as weak mortgage originations and issuance activity. The new regulatory safeguards have had their intended effect of reducing the amount of risk taken by financial firms. But for OB clients and others to expect a reduction in risk without causing some impact on liquidity is trying to have it both ways.

Optimal Blue clients know that capital markets have fundamentally changed during the last few years. These changes are a direct outcome of the excessive risk-taking before the housing crisis and the subsequent policy, regulatory, and industry response to reduce that risk. Although the days of market panic are long gone, the after-effects of the crisis—including the near-universal focus on de-risking among consumers, industry, and regulators—continue to drive the trends described in this brief. There are also no signs yet that these trends will reverse materially in the foreseeable future, leading us to believe that present levels of liquidity are here to stay.

And lest we forget, the Fed continues to be a player. The Fed’s ownership share of outstanding agency MBS is unlikely to budge until the Fed changes course. Even though the quantitative easing program has ended, the Fed continues to reinvest principal pay downs from its agency MBS and agency debt holdings to purchase new mortgage-backed securities. This means the dollar volume of Fed’s holdings will remain constant at roughly $1.7 trillion as long as this policy remains in place. The only other way Fed’s ownership share could shrink is for total MBS outstanding to grow faster than Fed’s purchases. This seems highly unlikely given the anemic level of net new issuances in recent years and a struggling purchase originations market.

So many analysts gravitate toward the idea that net new issuance volume would not only have to increase substantially from the current level, but would also have to remain elevated for a number of years before it could put a meaningful dent in Fed’s ownership share. And few think that this will happen.

A large number of Optimal Blue’s clients are still seeing a large portion of their business come from refinancing. These take the form of conventional, FHA, streamlines, etc., but suffice it to say that the end of the refi era has not happened.

But that isn’t to say that OB clients, and other lenders, are seeing as much refi business as they were earlier this year. Last week’s MBA refinance index release indicated that overall refinance activity is around 3% lower than what was seen prior to the introduction of TRID on October 3rd. Many analysts believe that the recent rally in mortgage rates (down to about 3.75%) should prevent refinance activity from declining to the levels seen prior to the introduction of TRID when mortgage rates were at 3.85%.

This is because, per analysts, that the TRID introduction is unlikely to have caused a large change in the number of applications that originators are willing to accept. One important metric that has been largely ignored by the market is the average loan size of the refinance loan applications. The average loan size of the MBA refinance loan applications spiked last week (prior to the introduction of TRID) and remained high this week. This indicates that the total UPB of applications is still 5% higher than application volumes seen prior to the introduction of TRID.

Since the average loan size was almost unchanged from the previous week near peak levels of $304K, on a nationwide basis one can expect that the prior week’s spike in the refinance index was the result of a pull forward of applications that would have otherwise shown up this week. This is not a surprise to any of OB’s client’s lock desks. Thus, the introduction of TRID appears to be unlikely to have caused lenders to accept a materially lower number of applications in total.

In other words, if 30-year mortgage rates remain around current levels of 3.75% then we can see the MBA refinance index gradually drift higher.

That being said, however, OB clients know that rates are not the sole determinant of refi business. Discussions with LOs indicate that “life changes” are an important piece of the refi puzzle. Events like a divorce, consolidating a 1st and a 2nd into one payment, and ARM into a fixed-rate loan, borrowing to unleash equity for various reasons, and so on are popular reasons. It is not an LO saying, “I was standing in a supermarket line with a gal and she was asking me what I did for a living and I told her and she said her rate was 6% and asked if I could save her any money…”

Still, many LOs say their biggest impediment to new business is their old clients that they’ve put into 3.50% 30-year fixed-rate loans. The sales pitch has to be very convincing to move a borrower out of that rate and into something else. And thus OB clients have other tools and arguments at their disposal to help borrowers refinance. Once a borrower heads down the path where the application is taken and a rate lock put in place, the loans are more “sticky” than they were in the past. Lenders normally report 80% or better pull through consistently.

So will refinancing change in a post-TRID world? Probably not noticeably. Borrowers still want to borrow, lenders still want to lend, regardless of the process.

Much of mortgage banking, and for that matter law as well, tries to answer the “what if’s”. What if something goes wrong? What if a borrower doesn’t make their payment? What if a document isn’t signed? Optimal Blue clients that sell loans to investors know that much of the seller agreement revolves around addressing items before they go wrong.

Many of OB’s clients sell loans directly to the agencies, and thus Fannie Mae and Freddie Mac announcing updates to their representation and warranty framework that governs the rights and responsibilities lenders face when selling loans to the GSEs attracted a lot of attention. One of the things that keep lenders up at night is repurchases, and if repurchase requirements are vague that is bad. Although the changes don’t take effect until January they were still welcomed by sellers.

Fannie gave out a list of potential alternatives to repurchase that it could offer in the event of underwriting defects. In addition, Fannie Mae provided specific guidance on what kinds of loan defects could lead to a repurchase request or an alternative remedy. The Bulletin reminded its clients that, “The remedies framework is specifically related to corrections of identified origination defects, and available repurchase alternatives. This framework provides clarity on the process followed in categorizing origination defects, lender corrections of such defects, and available remedies. In addition, it provides more transparency regarding Fannie Mae’s discretion on loan-level decisions when reviewing a loan during a quality control review. The remedies framework does not affect any servicing duties, responsibilities, or obligations.”

Freddie Mac spelled out its process. After completing a full-file quality control review, Freddie Mac will categorize defects in one of three ways: Findings, Price-adjusted loans, and Significant defects. It would be wishful thinking to believe that OB clients will never have any of them. Mortgages with defects categorized as “Findings” will not require a Correction or a Remedy (as defined below) from the Seller. Loans categorized as “Price-Adjusted Loans” require the Seller to pay the applicable post-settlement delivery fee (“delivery fee”) that should have been paid to Freddie Mac when the Mortgage was delivered. If a Mortgage has one or more defects categorized as a “Significant Defect,” Freddie Mac will require the repurchase of the Mortgage, or may offer the Seller/Servicer a repurchase alternative.

Fannie did the same. Fannie Mae will categorize defects in one of three ways, mirroring Freddie: Findings, Price-adjusted loans, and Significant defects. Mortgage loans with defects categorized as “findings” will not require a correction or a remedy from the lender. Loans categorized as “price-adjusted loans” require the lender to pay the applicable loan-level price adjustment fee (LLPA) that should have been paid to Fannie Mae when the loan was purchased or securitized by Fannie Mae. If a loan has one or more defects categorized as a “significant defect,” Fannie Mae will require the repurchase of the loan, or may offer the lender a repurchase alternative.

There is indeed some good news. Key terms are now clearly defined and lenders are afforded the right to correct loan-level defects before facing financial remedies. OB clients know that the standard process for “fixing” loans is to first try to correct the problem, and if that doesn’t work to go back to the borrower and try to refinance them – often at a loss. Lenders will have greater access to repurchase alternatives as well as representation and warranty sunset relief.

Old agreements stand. “In adopting the remedies framework, we are not discharging Sellers from responsibility for underwriting and delivering investment quality Mortgages in accordance with the terms of the Purchase Documents.” But the Bulletins should help OB clients going forward!

Yes, the sun came up the next day after the changes caused by “Know Before You Owe” were implemented. Borrowers still need to borrow, lenders still want to lend. But there are some things for Optimal Blue clients to keep in mind and remember.

First off, compliance folks are fond of saying, “Start old, stay old.” If a borrower’s application was taken October 2nd, the day before implementation, even if the disclosure were sent out afterward, OB clients (and others) should use the old process and forms. And the loan should be closed on the old forms: the process and paperwork are based on the application date.

The industry has begun to use the term “Loan Estimate”. Lenders cannot require verification documents from consumers before issuing an LE, and are required to obtain consumers’ consent to receive electronic loan disclosures and documents, and have contingency plans for alternative delivery methods. The lender will provide an LE within three business days after receiving the six pieces of information constituting an application.

Some mortgage costs can increase at closing, but others can’t. It is illegal for lenders to deliberately underestimate the costs on a borrower’s LE. However, lenders are allowed to change some costs under certain circumstances. The CFPB reminded borrowers that if their interest rate is not locked it can change at any time. And “even if your interest rate is locked, your interest rate can change if there are changes to your application information or if you do not close within the rate-lock timeframe.”

OB clients and others need to prepare the LE with reliable data and information collected based on good faith efforts (no padding fees). And any revisions to the LE must be issued within three business days of receiving information constituting valid changes of circumstances in order to reset tolerance baselines.

There are costs that can increase by any amount. These costs are not controlled by the lender, and can increase by any amount at any time. They include prepaid interest, property insurance premiums, or initial escrow account deposits, fees for services required by the lender that borrowers have shopped separately for, if they choose a service provider that is not on the lender’s written list of providers, and fees for third-party services that the lender does not require.

There are costs that cannot increase at all. If there is a “change in circumstances,” these costs can change by any amount, but otherwise they cannot change at all. For example fees paid to the lender, mortgage broker, or an affiliate of either the lender or mortgage broker for a required service, fees for required service that the lender did not allow borrowers to shop separately for, when the provider is not affiliated with the lender or mortgage broker, and transfer taxes.

There are costs that can increase by up to 10 percent. If there is a “change in circumstances,” these costs can change by any amount. If there is no change in circumstances, then the total of these costs cannot increase by more than 10 percent: recording fees, and fees for required services when the borrower has chosen a third-party service provider on the lender’s written list of providers (if the provider is an affiliate of the lender, the cost cannot change at all).

Lenders are not allowed to issue any revised LE after issuing the Closing Disclosure (CD), and must ensure that consumers receive the last revised LE and the CD at least 4 business days and 3 business days before consummation, respectively.

There has been plenty of press warning borrowers that they will encounter lengthier waits to close on the purchase of their home. Will real estate agents or builders know that? Good question and LOs are wondering if their clients will realize it. Thirty-day waits are now common in some markets. But 45- or 60-day waits may become more common as OB clients and all lenders familiarize themselves with the new rules.

National Cheeseburger day was September 18th. The day after was a letdown for many connoisseurs and followers of that burger. There are some similarities between that feeling and the feeling that traders, analysts, and bankers had after the Fed left short term rates alone after its last meeting. Is that a bad thing for Optimal Blue clients? No – and some would argue it makes little difference anyway.

So, it was a “no go” for the rate change in September. Now the world has to wait for a Christmas present from the FOMC. Remember when you were a kid and you wanted something you were really passionate about like the newest gadget or a cool toy and instead you got socks? Hopefully the FOMC doesn’t give us socks for Christmas and raises the rate everyone is hyped up for, like that latest toy. And OB clients should remember that there are a few more Fed meeting before the end of the year, and Chairperson Janet Yellen has recently indicated that the Federal Open Market Committee is still targeting a rate bump before year end – if the economics of the world can handle it.

While a great majority of the FOMC expects a rate increase by the end of the year, others believe there is some uncertainty in that idea. The fact that global developments were brought into the discussion during the September meeting is a sign of uncertainty. One group opined, “We believe that a resolution of the global picture is unlikely to provide much guidance in the short run… Perhaps the global issue is just a temporary reason for no action. If so, this simply adds to uncertainty given that the global situation has made a sudden appearance and that these developments are difficult to quantify and unlikely to change much before the end of the year—yet a great majority expect to raise the funds rate by the end of the year? Uncertainty persists.”

What else did the FOMC do during its last meeting? There were a lot of expectations being lowered. The committee lowered its expectations for inflation over the next three years and economic growth in 2016 and 2017. The FOMC also lowered its expectations for the overnight Federal Funds rate over the same period. You know what they say about expectations: keep them low so when it happens you can only be impressed.

The FOMC continues to set expectations for the market. But there is a pattern of consistent overestimation and lowering expectations. If one looks back at the press releases and minutes the FOMC has consistently overestimated the path of the federal funds rate. This appears to indicate that whatever the link is between the funds rate and economic growth, the link is weaker and that other factors are influencing both.

Overall this suggests the potential growth rate of the economy has shifted downward. Moreover, the lower path of nominal GDP growth over the next three years presents a challenge to financial markets as lower nominal GDP would be consistent with lower growth of corporate profits. If that is true, OB’s clients can expect mortgage rates to stay low – much as they’ve done since the FOMC meeting. That is not a bad thing, although it might be better if the Fed indeed saw reasons in the U.S. and global economy to raise rates.

When the Fed failed to make a change to policy, the markets took this as a reflection of concern by the Central Bank regarding the prospects for growth. Now, I’m going to grab a cheeseburger to boost my mood.

Optimal Blue’s clients use a variety of secondary market execution strategies. Some sell everything on a best efforts flow basis while others securitize their own loans. On the other end some investors prefer to originate loans for their own portfolios, some buy blocks of whole loans, while others prefer to buy mortgage-backed securities (MBS). Why should OB’s clients be interested in hearing about why MBSs are seeing renewed interest? Because the demand for mortgages impacts the rates that LOs and borrowers see on rate sheets.

Investors know that MBS generally have tended to offer a high degree of liquidity and a relatively low correlation to risk assets. The U.S. residential and commercial MBS markets exceed $7 trillion and make up about 30 percent of the Barclays U.S. Aggregate Bond index and 12 percent of the Barclays Global Aggregate index, according to the Securities Industry and Financial Markets Association (SIFMA) and Barclays, respectively. It is no surprise to OB’s clients that the largest and most liquid component of MBS exposure are mortgage bonds guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. There also are sizable private-label residential and commercial MBS markets.

But agency MBS valuations are not cheap at current levels. These securities are accompanied by both interest rate and prepayment risk. And prices have been inflated by the accommodative policies of the Federal Reserve, which owns more than $1.75 trillion in agency MBSs.

One factor contributing to the price movement of MBS is prepayment risk: borrowers can pay off the loan any time they like. Given that the typical U.S. 30-year mortgage loan can be prepaid at any time, MBS investors — the lenders — are “short a call option” to the borrower to prepay, or call, their mortgage at their discretion. Being short an option creates the exposure to volatility but over the long term, investors have earned attractive compensation for incurring this risk.

Excess returns from agency MBSs have had among the lowest correlation to risk assets of any fixed-income sector and, relative to like-duration Treasuries, the primary risk factor in agency MBS is prepayment risk. The credit quality has improved dramatically. Even within the credit component of the MBS market, any originator or underwriter can tell you that this component of loans, and therefor for pools of loans, has improved dramatically in recent years.

Liquidity is another key distinguishing factor of the agency MBS sector, especially in an environment in which regulation has reduced the role of intermediaries. The demand for a purple 747 will directly impact the price, just as with MBSs diminished liquidity can result in wider bid-ask spreads and more fragility during periods of market dislocation. Although liquidity in agency MBSs may be weaker than historical levels, according to SIFMA, on average, the sector continues to trade more than $200 billion in securities a day with decently small bid/ask spreads..

But not everyone agrees all the time about the value of a given asset, and that is what helps make a market. The complexity of the mortgage market (pools of various LTVs, credit scores, geographic breakdowns, loan amounts, etc.) has facilitated consistent, excess return potential – there is opportunity! Prepayment risks are intricate, and sophisticated MBS investors often disagree materially on the value of embedded call options. Given the large footprint of investors not driven by total-return goals, the agency MBS market is constantly dislocated and mispriced.

OB clients should be aware that the MBS market offers the potential for investors to outperform Treasuries without drastically increasing the correlation of their fixed-income holdings to their equity exposure. The agency MBS sector historically has demonstrated a tendency to successfully address these goals while also providing attractive opportunities for active managers to generate excess returns. And that helps continue to keep mortgage rates low!

Remember when you were a kid and you used to build towers out of blocks as high as they could possibly go until they all came crashing down prompting your mother to tell you to not build your tower so high and the blocks wouldn’t fall? This is the scenario of the inventory investments for the second half of the year. In the first quarter, inventory investments increased $112.8 billion and increased another $110.0 billion in the second quarter, which is the largest back-to-back inventory accumulation on record. That’s a tall tower of blocks. What does that mean for mortgage rates for Optimal Blue clients?

Most economists believe that in the second half of 2015 inventories will unwind and they say that the higher the inventories go, the greater the eventual toppling could be and the greater the potential drag on GDP growth. And if GDP declines because of it, we can expect rates to follow.

A substantial inventory adjustment in the third quarter could affect the timing of expected FOMC tightening. What kind of drag is coming? Well due to lag time on reporting of inventories most economists seem to think that in the third quarter the “inventory build” will be $75-85 billion which, if that is correct, would result in 0.7% drag on GDP. To put that into perspective, in the first quarter when people were complaining about slow growth of GDP at 0.6%, inventories held GDP in the positives with a 0.9 percentage point boost. Without the growth in inventories, first quarter growth would have been negative.

For the OB clients who are optimists, however, there are more optimistic forecasts as well, with $100 billion, which would only result in a 0.2% drag. For example, Wells Fargo’s team notes, “The average inventory change in 2013 and 2014 was $61.4 billion and $68.0 billion respectively; if we penciled something in that range, the resulting drag would be about 1.0 percentage point. A $50 billion inventory accumulation would exert a 1.5 percentage point drag and “no change” in inventories would mean a 2.7 percentage point drag, or enough to swamp even an optimistic forecast for broader economic growth outside of inventories.”

So where did all of the buildup of inventories come from? Some people would be quick to jump to the conclusion that with more crude oil being pumped then Niagara Falls has water the energy sector is the primary culprit for the recent buildup.

But there is more to it than that. Energy is clumped into the “other” inventories, which includes mining, utilities and construction sectors, and therefore some of the influence of the energy sector. Inventory building has also picked up in the manufacturing and trade sectors.

But the most significant increase in the first quarter came from motor vehicles and part industry, where manufacturers and wholesalers saw inventories rise by the most in the series’ 18-year history. Some of these buildups aren’t unintended with many of the inventories keeping pace with sales. “So if the inventory build in some of the standout sectors is not necessarily unintended, what about the inventory build for the U.S. economy as a whole? Is it possible that the largest back-to-back inventory build on record is justified?” The aggregate I/S ratio for all manufacturing and trade sectors have shot up over the past year. Taken at face value, the run-up in the aggregate I/S ratio suggests that the build in real inventories in the first half of the year is unintended.

Overall, the back-to-back $110 billion+ gains are unprecedented and set us up for an inventory unwinding that could be painful for growth in the second half of the year. And OB clients know that what is painful for the economy is often beneficial for rates.

As rates have come back down and the chances of a September Federal Reserve move diminish, we find ourselves heading into the last week of August. This is also the traditional wind-down of the purchase season, as real estate agents know. Although the relationship between an LO and a real estate agent is often times complex, actually LOs and agents have a lot in common in dealing with clients and telling them what, or what not, to do during the process.

Experienced LOs of Optimal Blue clients typically tell borrowers not to schedule a vacation two weeks before or after the scheduled loan funding. Everyone in the residential real estate world knows that the weeks prior to and after a targeted closing date are a whirlwind of activity. Usually documents must be found, or re-sent as the case may be; papers must be signed, and so on. An already stressful process is going to become even more stressful.

Values have been increasing in many parts of the nation, but real estate agents and loan officers often deal with parties who believe that the house is worth more than those of the neighbors. In neighborhoods with unique homes this might be the case, but in many subdivisions it is not. Sellers, of course, think their house is larger, nicer, and in a more desirable location. Houses and apartments are worth a similar amount as to what comparable ones have recently sold for, in spite of what Zillow or Trulia may have estimated. Setting appropriate expectations are a very important component of what agents and loan officers do with their clients.

Real estate agents will often tell borrowers that, during the “walk-through,” it is not worth fighting over a broken appliance or missing light fixture. The client is going to spend hundreds of thousands of dollars or more to buy a home so these items are of little consequential or incremental value. Some, however, believe that items like that are indicative of other problems – it is a judgment call. Real estate agents spend a fair amount of time reminding clients that they are going to spend many thousands of dollars more updating items; repairing items and making this house their home. A buyer’s agent may even pretend that these items are important and “fake” indignation at their state of repair. But, though they are doing this to placate a client’s emotional response and coax them to the closing table, this is really just much ado about nothing.

Loan officers will usually inform buyers that scheduling is critical, and to keep in mind that the actual closing of one property and the purchase of another do not always coincide. Though it is everybody’s dream to sell their property in the morning and buy their new property in the afternoon, this is almost impossible to achieve. In a house transaction there are usually at least six parties involved and with a co-op 8 on each transaction. With busy schedules, vacations, holidays, etc., having this many people lined up on the day and time that work for a borrower is usually an insurmountable task. There are plenty of borrowers, or sellers, spending time at motels and hotels around the nation waiting for a day or two for the deal to close.

Optimal Blue’s clients are filled with stories of deals gone awry. Again, selling and buying a house is very stressful. So, when stress can be avoided by an LO or agent setting expectations, it is time well spent.

If you would like to know how to pick a lock like they do in the movies, I would suggest consulting YouTube (although that may not be the most productive use of your time, it probably will be very (not) necessary for your entire life). If you would like to know more about rate locks and how their expirations can affect you, continue reading. Virtually every Optimal Blue client accepts rate locks. Residential lending is one of the few businesses where consumers can lock in a future price now.

How important is the rate lock expiration date? It is very important if rates have stayed the same since an OB client’s borrower locked in their rate and terms, extremely important if rates have climbed since a borrower locked, and somewhat important if rates have improved since you locked.

Most lenders offer different options for lock periods: 15, 30, 45, or 60 days are the standard while 90 and 120 days but those usually require a deposit. Most believe that with TRID approaching in early October that the 30-day rate locks will become rare. But with each longer period that we lock the price of the loan is incrementally higher, i.e., a 15 day lock may cost 1.25 points, the 30 day lock 1.375 points, etc.

If a transaction is at the lock deadline date and the parties are not able to fund the loan, then the lender will have to extend the rate lock to retain it. At that point it depends on the market if there will be an additional fee to extend the rate or not. This is where the importance of the rate lock deadline comes in. If the market has improved, many lenders, in order to remain competitive, often get a short term extension at no cost. If the market has remained the same then a very short time extension at no cost may be possible depending on the loan amount, type of loan, if loan docs are out and signed and how many days are required.

Often, even if the market is the same, a fee to extend is still required. While it may seem obvious, what borrowers don’t want is for the market to worsen and to need an extension; there will most certainly be a fee associated with the extension. For OB clients generally the cost is more expensive to extend a loan after it is locked than it would have been to pay for the longer lock period up front.

For example if a borrower has a $400,000 loan that is at 80% loan to value and could have locked on May 15th for 1.375 points for 45 days, but instead locked it for 30 days at 1.25 points, and here we are on Friday June 12th and we are not ready to close yet because the buyers of the home do not yet have loan approval, and the lender needs the equity from the current home to close, then the lender cannot fund on Monday June 15th when the lock expires. Continuing, today the rate for the same loan is considerably higher than it was on May 15th by 0.25%. It looks like the OB client needs 10 more days to get the buyers’ loan approval, their loan docs, and then fund both loans. This lock extension in the current market will probably cost the borrower 0.25 points, or $1,000 on a $400,000 loan.

Had they locked the loan for 45 days at the beginning of the transaction the cost up front would have been only 0.125 points, $500, more than the lock the borrower decided they needed. People will then ask, “What if I let my rate expire and rates improve?” You will not get the rate improvement unless a significant time as elapsed, usually 90 days or more. Essentially, buying the longer loan lock is insurance to not go over.

Optimal Blue clients, and anyone in residential lending, have had their fill of government. Unfortunately election season is officially upon us – it seems to become longer and longer. Regardless of your views of President Obama, it is almost time to elect a new leader. But how does the election process work, and why should lenders care?

Think back to your class in government in high school. The highly advanced Electoral College anyone? The election process was born in 1788 from indecision between letting a popular vote decide the president and letting Congress make the decision (glad that didn’t happen… Federal Government shut down of 2013 anyone?). The two sides eventually formed the Electoral College.

Now, let’s get down to business by breaking down the different parts of the election process. The primary process: The primaries decide who is going to represent the two major parties in the Presidential Election. It’s all about money and support, and some of the candidates actually discussing things like Dodd-Frank, the CFPB, and housing issues.

A candidate starts by forming an exploratory committee to determine if a critical mass of support and the necessary funds needed for a presidential campaign can be raised. Coinciding with a candidate’s exploratory committee are fundraising organizations, known as Political Action Committees (PACs) which help raise funds to promote actual campaigning.

Before the presidential debates, there are primary debates in which the primary candidates of each party debate others in the same party. The primary voting (caucus) follows, and the date varies by state. Some states are in January; some are in June so most candidates try to strategically campaign in the early caucus states to build momentum. If candidates don’t get wins/good showings in the early caucuses, they will start to lose money and have to exit the race (and they usually start to endorse another candidate in their party so they “stay” in the race). The Democrats and Republicans eventually decide who is going to represent them in the general election. When a representative from each party is chosen, the most important part of the process comes: red, white and blue balloons fall from the ceiling in celebration!

Now comes the final hoorah: the general election. There are the Presidential debates in which the representatives square off to tell the country their plans for the future, aka telling America what they want to hear and maybe, probably not doing it. Housing and job issues are typically of paramount importance. For example, OB clients know that each client will have a different idea about Freddie Mac and Fannie Mae.

Eventually, in November of 2016, will be the voting. An interesting demographic to note is the change in voter age and race since 1984. The age of voters was evenly split among the 3 age brackets in 1984 and now is a large majority voter’s aged 55+. The race of voters has changed from 87% white to 76% white.

The first part of voting is the popular vote in which all of the votes from every person are tallied up to see who got the most votes. One would think that would decide who the president is but they would be wrong. All of these votes go into the Electoral College, which seems to work unless you’re Al Gore – then you hate the system. The Electoral College is essentially a winner take all system for states. The candidate with the most votes in each state gets all of the Electoral Votes for that state (except Maine and Nebraska). The number of Congress seats in each state determines the number of Electoral Votes for each state.

Through the entire process housing, and therefore lending, will act as a lightning rod for comments and speeches. Generally politicians know little about how the lending process works, what a warehouse bank does, or the different between a broker and a banker. But OB clients and everyone else will have to endure the race.

In January of last year the residential lending world was divided into two pieces: QM and non-QM. Although Qualified Mortgages held the position as the leader, many thought that non-QM loans would accounts for hundreds of billions in originations. Instead, we find that non-QM lending is limping along, and that QM loans still rule for Optimal Blue clients as well as most lenders. What happened?

Starting a new program is not as simple as throwing a switch. Lenders are still very concerned with potential litigation risk down the road. Certainly anyone can sue anyone else at any time, for whatever reason. But many lenders still hesitate to offer a product that is still, and mistakenly, confused with subprime. There is “performance risk” – are these loans going to perform poorly compared to QM loans? What will early defaults be like? And lastly there’s “reputational risk.” Many lenders have made fine names for themselves in originating QM loans, and don’t want to “mess it up” by becoming known as a non-QM lender.

That being said, other lenders believe that the future is in non-QM lending. Many minorities, the source of new home ownership, are seen as falling into non-QM programs. The risk culture of a lender may lend itself to non-QM programs, as might the “credit culture” of a given lender. These lenders may be more inclined to view (in order) LTV, FICO, and DTI as drivers of loan performance.

Light was shed on the QM versus non-QM topic last week when the Government Accountability Office (GAO) released a report examining the effects of the CFPB‘s regulations establishing standards for qualified mortgage (QM) loans and the final qualified residential mortgage (QRM) rule jointly issued by six agencies. The GAO found that these regulations would have “limited initial effects” because recent loans already largely conformed to criteria set forth by the QM rule.

“Mortgage Reforms: Actions Needed to Help Assess Effects of New Regulations,” was conducted by the GAO at the request of Congress amid concerns that risky mortgage products and poor underwriting standards were contributing factors to the housing crisis of 2008. Unfortunately for any politician who wants to encourage home ownership, these QM criteria have also helped contribute to a decline in home ownership percentage.

Optimal Blue clients know that QM regulations address lenders’ responsibilities to determine a borrower’s ability to repay a loan and include prohibitions on risky loan features, such as interest only or balloon payment, and limits on points and fees, according to GAO. QRMs are securities that are collateralized exclusively by residential mortgages, and they are exempt from risk retention requirements. According to GAO, securities collateralized solely by QM loans are also exempt from risk retention requirements.

And don’t forget: the QRM rule is scheduled to go into effect in December 2015. GAO’s report estimated limited effects of these regulations on availability of mortgages for most borrowers. The report also found that litigation and compliance issues would be at the root of most cost increases for borrowers, lenders, and investors. The QRM regulations were not expected to have a significant initial effect on availability or securitization of mortgages, according to agency officials and observers, because QM loans were expected to comprise the majority of loans originated. GAO stated, however, that the size and viability of the secondary market for non-QRM-backed securities remained in question.

The GAO recommended that “CFPB, HUD, and the six agencies responsible for the QRM regulations should complete plans to review the QM and QRM regulations, including identifying specific metrics, baselines, and analytical methods. CFPB, HUD, and one QRM agency—the Federal Deposit Insurance Corporation—concurred or agreed with the recommendations. The other QRM agencies did not explicitly agree with the recommendations, but outlined ongoing efforts to plan their reviews.”

Thus we find that non-QM lending is a work in progress, and will continue to be subject to debate.

For months the markets seem to have been focused on the debt problems of Greece, and on whether or not the European Economic Union would survive. Sure enough, the parties involved came to an agreement. And whether or not it is merely kicking the proverbial can down the road, the problems have been removed from the headlines.

So now what? It seems that in the last week or two we’ve begun focusing on what is happening in this country again. More specifically, what the Federal Reserve Open Market Committee is up to. After all, the austere group meets this week. The Fed Funds rate has been camped between 0 and 0.25 percent since 2008. Many in residential lending have never seen it higher. And top Fed officials, including Chair Janet Yellen, have telegraphed for months that they expect to finally raise it by the end of the year.

It would stun the markets if an increase came this week, so what about September? Analysts say the most likely way is for the central bank to raise its target rate in September. But there is a contingent that has argued for “liftoff” in December or later. But they are not mutually exclusive: the Fed could raise its target rate in September and leave it unchanged for the rest of the year, or the Fed could raise rates a second time in December and still average a 0.35 percent fed funds rate for the quarter.

The central bank has stated it believes the increase in the fed funds rate to more normal levels will be gradual – but that is pretty subjective. And it isn’t shocking news to anyone that the changes are based on data as the economy changes, and then it comes down to how the economy actually performs compared to expectations and official projections. Inflation, for example, is not expected to hit the Fed’s target of 2 percent until 2020 – but we see housing and minimum wages going up all the time around the country. Forecasts from Fed officials are based on what they believe should happen, but other forecasts are based on what is most likely happen – and there is a difference.

And once again we remind Optimal Blue readers that there is little direct correlation between Fed Funds and mortgage rates. Yes, they are influenced by many of the same factors. Generally, an expanding economy causes the demand for capital to increase, and supply and demand dictates that rates would increase as a result. But overnight Fed Funds’ rates are set by the FOMC.

So what about mortgage rates? They are still being helped by the Federal Reserve buying billions every week of agency MBS. This, combined by demand from banks, insurance companies, money managers, and the like, lead to the general supply & demand trend being in balance. Specifically on the Ginnie Mae security side of the market, it also doesn’t hurt that we’re now several months removed from the Mortgage Insurance change and compensating interest change. And lenders are going through their loan level price adjustment (LLPA) changes and removing the adverse market fee that we’ve had for years.

So experts believe, with good reason, that mortgage rates would be higher if the Federal Reserve was not weighing on the demand side of the equation. True. But the fact of the matter is that they are, and will be for the foreseeable future. And the MBA just ratcheted up its 2015 volume estimates… something must be working!

Well, the Greek issue is settled, right? Maybe the better claim is that Greece is out of the headlines…for now. There are certainly many experts who think that the deal reached over the weekend is merely kicking the proverbial can down the road. Certainly the deal has stocks rallying everywhere, but let’s take a look at how the announcement impacts the bond markets, interest rates, and thus Optimal Blue’s clients.

Early Monday morning the European Union leadership formally announced the achievement of a EU80B debt deal with Greece. The arrangement has strict conditionality, and Greece will be required to pass through its parliament a series of reforms by Wednesday (July 15) before substantive negotiations can even begin. Tsipras wound up “caving in” on nearly every demand of the EU leadership, including the creation of a EU50B trust fund into which Greek state assets earmarked for sale will be placed (this fund, thought of as an escrow account, will be beyond the control of the Athens government).

The one concession granted to Tsipras concerned Greece’s debt. The Prime Minister secured a stronger commitment by creditors to restructure the country’s massive debt load. While the Greek political climate is more amenable to compromising with the rest of Europe (since Prime Minister Tsipras is now presiding over a quasi-unity government), the country’s financial outlook is even bleaker than before. In fact one senior EU official calculated the cost to the Greek state of the last two weeks of political and economic turmoil at EU25-30B.

There will probably be two Greek deals: an interim (1-3 month) one would help it cure the International Monetary Fund arrears and make the upcoming ECB payments (the first of which hits 7/20). A second deal needs to be put in place that will last 2-3 years.

Greece will achieve more debt relief – and has critics saying that this is merely kicking the can down the road. The net present value of the country’s debt load will most likely be reduced again. OB clients can think of it as a loan modification and principal reduction, should it happen as expected.

Unfortunately for anyone with money in a Greek bank, the Greek banking system has suffered irreparable damage and a best case outcome will probably see a wave of recapitalizations and consolidation. Greece will still be subject to strict auditing by the troika and as a result any slippage (either in economic growth or the pace of reform implementation) could result in financing being withheld again.

So Greece will have capital controls that will probably stay in place. The Greek shipping industry is nervous about the new tax proposals since higher taxes (in theory) could drive that industry out of Greece. Greeks may not be able to retire at such a young age, and pensioners will probably be impacted – but it merely moves them closer to practices carried out in much of the rest of Europe (and the U.S.).

Given that Greece has the economic size of Indiana or Michigan, the Greek saga never inflicted substantial damage on growth or financial markets. It is almost as if the press had little else to talk about: conjecturing about the “what if’s”! And so the U.S. bond market can switch its focus from Greece and the Eurozone to the Fed’s outlook on raising interest rates later this year. Thus the “flight to quality” bid is removed from our markets. And if there is indeed economic peace in Europe, we’ll either focus on China’s problems or our own economy – stay tuned!

Optimal Blue clients know that without a secondary market for the mortgages they originate, things become grim very quickly. Mortgage banks borrow money from others (warehouse lines) to fund a loan and pay them back when the loan is sold – to an investor. Yes, banks put some loans into their portfolios – but not all of them. There is no way a company like Wells Fargo or Chase could put every loan they originate onto their own books. So yes, selling loans into the secondary markets where they usually end up being put into securities is a fact of life for residential lenders.

A lot of attention is focused on Greece, but let’s not forget that a couple weeks ago Barclays Plc announced that it is ending trading in $700 billion of U.S. mortgage bonds that were issued before the financial crisis, the latest move by global banks that are adapting to new regulations. Barclays will no longer regularly buy and sell these particular residential securities, which lack government backing, in an effort to refine its strategy meant to improve the return on equity.

One of the issues causing the change is the shift to adjust to rules introduced after the financial crisis that were intended to curb the risks of another meltdown, including demands from regulators for larger capital buffers. And these non-government loans are required by various regulators in various countries to have more capital. And given that most of the debt has been cut to speculative- grade levels, U.K. regulators now require banks including Barclays to hold even more capital against such junk-rated securities relative to other bonds. Barclays is not the first. Royal Bank of Scotland Group Plc’s investment bank said in November that it would completely exit the U.S. mortgage market.

So will this spillover into our market? For U.S. banks, ratings on mortgage bonds have become less crucial since lenders can use an alternative approach to calculating capital requirements that ignores the grades and in many cases reduces the amount needed for junk-rated mortgage bonds that are trading at discounts. On the supply side issuance has dropped as companies either aren’t originating the product or banks are squirreling it away in their portfolios. Some recent Chase figures showed that more than $700 billion of pre-crisis debt remains outstanding.

The margins are certainly good, but there are reasons. For example, the securities can be more expensive to trade than other debt, requiring work such as tracking potential legal settlements and using models to assess future loan performance. Supply and demand often go in fits and starts, and the lack of government backing causes investors to demand more yield.

On the jumbo side of things, there are many who believe that, when eventually they come along, higher rates will tighten spreads between jumbos and treasuries. But volumes should decrease too. And that perhaps hybrid jumbo production will increase. But the lending market continues bear the brunt of the high percentage of all cash buyers accounting for 30-40% of some markets. For some paying all cash is required to have an offer accepted, others believe that the return on their money is better in real estate than in a bank. And for others it is just “too much hassle” to obtain financing.

Every Capital Markets person in the last month has mentioned “Greece” during a meeting. And they are probably sick of talking about the country and the situation. But it is relevant to our markets and therefore Optimal Blue’s clients, so let’s take a look.

Greece: a great vacation destination due to cheap prices from a plunging economy. However, from a business standpoint, the high-stakes Greece debt crisis is the biggest worry there is to global investors. The crisis in Greece is overshadowing what usually would be on everybody’s mind: the June Job report and what it means for the Federal Reserve’s interest rate hike plans.

Instead, global investors everywhere are worrying about Greece and its creditors having not yet reached an agreement regarding the terms under which the final €7.2 billion tranche of the country’s current bailout program will be released. The question that needs to be answered: Greece did not reach an agreement by its June 30th deadline to pay back the IMF. So will it be forced to leave the Eurozone? This has already affected the banks in Greece; the European Central Bank said it wouldn’t increase its cash lifeline to Greek Banks, which will force the banks in Greece to be closed Monday. But, how will this affect the US?

Short term, stocks and bonds are likely to be volatile. We have certainly seen that. And it will affect the European economic outlook and global financial markets that will have a spillover effect in the United States.

How can a little country like Greece who has no real connection to the US other than vegetable trading, affect our stocks? The worry is that Greece heading towards default will prove contagious, which could affect the markets in Europe, which in turn affects us. However, while this is a large tragedy for Greece, there is no reason for widespread panic; it won’t affect US stocks as much as everyone fears.

With such a large debt at stake, however – $1.8 billion- if Greece is declared in default, creditors will have to deal with it and that will place a large amount of uncertainty. The big money repositioning itself will create the big moves. Bonds, which are safe investments in countries not directly exposed to the problem rose in prices. The bottom line with the stock market though is that the crisis in Greece will disrupt the stability of the market. A negative global outlook can have negative effects on our market and with this much uncertainty in the air it is hard to predict how large of an affect it will have.

If the Greek crisis is prolonged, a flight-to-safety in U.S. Treasury bonds could bolster the dollar, crimping exports and economic growth. This is bad timing because the Federal Reserve needs to see a positive outlook in the US economy for them to consider an interest rate hike. This was proven when Federal Reserve chair Janet Yellen said, “I do see the potential for disruptions that could affect the European economic outlook and global financial markets,” she said. “To the extent that there are impacts on the euro-area economy or on global financial markets, there would undoubtedly be spillovers to the United States that would affect our outlook as well.”

The situation in Greece, while it may not directly impact the US, is not something we can ignore. Greece seems poised for a likely default or exit from the European Union, which, either way there will be global ramifications which will impact the US financial markets and exports. With the US having continued growth, now is not the time to ignore the situation in Greece with the looming interest rate hike and to sustain growth.

Most hedging companies, and their clients, as well as lenders who hedge their own rate-lock pipelines do not use Treasury securities to hedge. After all, who wants to explain basis risk to their CFO or CEO when it moves against them? But some companies use Treasury hedges to some extent, and certainly movements in mortgage rates and prices are pegged to U.S. government securities. So sometimes OB clients wonder what has been happening there.

Certainly the difference between MBS and Treasury security movements is due in part to supply and demand. During the past week, 30-year production coupon passthroughs were in line with their Treasury hedges. The industry originates about $3-4 billion a day and the Fed buys $1-1.5 billion a day, (Remember – the MBA expects the industry to originate about $1.2 trillion this year over 250 business days.) Some analysts think that one important consequence of the dovish outcome from the June FOMC meeting is that the likelihood of the Fed ending or even tapering its pay-down reinvestments before June 2016 has decreased significantly. Thus, it appears likely that the range-bound movements of MBS spreads seen over the past few quarters will continue in the second half of 2015 as well.

Although the FOMC made no changes to monetary policy last week, many think it presented a more pessimistic outlook for 2015 than was expected. Are the Fed Governors turning skeptical about the economy’s prospects for growth despite the recent improvement in some key economic data? Perhaps – this skepticism may be reflected in the FOMC’s interest rate forecasts. In her press conference, Chair Yellen stressed that most of the Committee still expects to raise short-term rates later this year, but now almost half of the FOMC participants expect only one (or zero) hike this year.

Returning to the influence of supply and demand on the spread, agency MBS spreads have held up extremely well, even as the Fed had first tapered its MBS purchases and then ended the QE 3 program altogether last October. During 1H’15, MBS spreads have widened by 10-11bp in January but tightened back and have been trading in a narrow range since then. The shape of the yield curve has changed materially over the past 18 months, however, so the actual material change is somewhat subjective.

So where is the “equilibrium level” of MBS spreads? If the Fed continues its pace of buying securities, this debate will have to be revisited next year. It appears likely that the range-bound movements of MBS spreads seen over the past few quarters will continue in 2H’15. This is actually good news for any OB clients that use Treasury securities to some degree.

Good news for mortgage pricing is that demand for MBS from domestic banks and overseas investors turned out to be a lot stronger than expected in 1H’15. If this source of demand continues in 2H’15, it will be very difficult for MBS spreads to widen, therefore helping pricing

Agency MBS in the retained portfolios of the GSEs declined by about $60 billion during the reference period, but they are likely to decline by only about $30 billion in 2H’15. In addition, the Treasury sold about $25bn agency MBS during the reference period, but it is not involved in the market now.

But all is not rosy. Assuming that the 10-year Treasury yield remains above 2.30% for the remainder of this month, estimates peg paydowns on the Fed’s portfolio in July to decline to about $20bn. Thus, the Fed’s reinvestment needs will decline to only $20bn per month by early August (versus the $30-35bn range recently). While MBS spreads should benefit from the timing mismatch between the Fed’s reinvestments and originator selling over the next few weeks, the situation will change for the worse in early August.

Due to the time of year, the net supply of agency MBS is likely to be $15-20bn per month over the next three months. The net supply of agency MBS from organic growth is likely to be around $45-60bn in 2H’15 versus $20bn during the reference period. And GSEs are likely to reduce their agency MBS holdings by $30bn between now and the end of the year because of the new (additional) 90% cap on their retained portfolios suggested by the FHFA.

No one can predict the future, but it doesn’t look too bad for agency MBS prices versus those of Treasury securities.

When the market has been volatile, as it has been for the last month or so, Capital Markets and lock desk personnel are inevitably asked, “How important is the lock expiration date?” Often this question comes from newer LOs, but it is good for Optimal Blue clients to remind everyone in the “food chain” of a loan about the importance of time. And to remind them that rate & price locks are unheard of in most businesses.

A lock expiration date is important if rates have stayed the same since you locked in your rate and terms. The secondary marketing group has planned on that loan funding by a given day, and often times will have committed that loan to an investor – even if it is the bank’s portfolio department. And the expiration date is extremely important if rates have climbed since an LO locked, and somewhat important if rates have improved since they locked.

Most lenders insist that certain minimums be met in order to lock in a rate. Many require the following: a) to know the borrower is approvable for the loan desired, b) the loan amount, c) the sales price, d) the property address, and e) estimated closing date. With this information the originator can obtain an accurate quote for based on the borrower’s credit score, loan amount, loan to value, and the length of time the OB client needs to lock in the rate.

Most in the business know that lenders have the option of locking in a rate and price for a specific period of time, 15, 30, 45, or 60 days. Some offer extended rate locks for longer periods but many lenders require a deposit for borrowers to lock for 90 or 120 days, or perhaps even longer. With each longer period that the lender locks the price of the loan is incrementally higher/worse, i.e. a 15 day lock may cost 1.25 points, the 30 day lock 1.375 points, etc. The reason for this is that, basically, a dollar is worth more to you (or anyone) now than it is at some future date.

If the lender is at its lock deadline and is not able to fund the loan then the lender has to extend the rate lock to retain it. At that point it usually depends on the market if there will be an additional fee to extend the rate or not. Capital markets departments see a common occurrence of LOs trying to game the system by locking a loan in for 30 days, at the better price, in spite of knowing it will take 45 days to fund the loan.

If the market has improved LOs can sometimes receive a short term extension at no cost. If it has improved dramatically they may be able to “float down” the rate, specific terms and conditions apply to do this however.

If the market is the pretty much the same as it was when the loan was locked loan officers may be able to negotiate a very short time extension with the lender at no fee. This has many variables however depending on loan amount, type of loan, if loan docs are out and signed and how many days are required. Sometimes, however, even if the market is the same the circumstances will require a fee to extend the rate lock period.

If the market has worsened and rates are higher and we need to extend the rate then there most certainly will be a fee associated with the extension of the rate lock—and generally the cost is more expensive to extend a loan after it is locked than it would have been to pay for the longer lock period up front.

Uh oh. Rates have moved higher. Everyone in the world knows that commodity prices fluctuate, as do stocks and bonds. Rates have been moving higher, gradually, for several months. And although there are still those that think rates should be lower, they are what they are.

When rates began to rise Optimal Blue clients watched savvy investors use valuation as their guiding light, and they paid attention to how central banks are reacting. Interestingly enough, valuations remain demanding and central banks have yet to show much concern about recent moves. But some investors are trimming back on mortgage-backed securities ahead of more volatility – why?

The odds favor a change in short term rates later this year (probably not this month). It will be the first time in roughly a decade that rates have been moved higher. Investors who focus on agency mortgage-backed securities are especially concerned about what policy makers do after liftoff: the unwinding of the Fed’s balance sheet, including its $1.72 trillion in MBS – about a year’s worth of production. And as the Fed reduces its $4.5 trillion portfolio, MBS investors can expect a double dose of volatility as soon as the end of this year. The Fed holds about 20 percent of marketable U.S. Treasuries and about 30 percent of the agency fixed-rate MBS market. Since mortgage securities trade at a spread over Treasuries, their yields will get bumped twice as the Fed reduces its balance sheet.

We can expect rate sheets to show it: homebuyers will face higher mortgage rates. But nothing is certain. Policy makers said they will lift rates in 2015 if unemployment continues to fall and inflation shows signs of rising toward their 2 percent target. And who can say with certainty if and when those things will happen? After an initial rate hike it is thought that the Fed will eventually begin reducing their balance sheet by no longer reinvesting in Treasuries and MBS (to the current tune of $1-1.5 billion a day).

Remember that short term rates are set by the Federal Reserve whereas long term rates are purely set by supply and demand. Shortly before lowering short-term rates to near zero late in 2008, the Fed began using bond purchases to press down longer-term yields in a bid to further stimulate the economy. The quantitative easing (QE) ended in October 2014. And yes, the economy was stimulated, but wage growth has been missing. And if rates creep higher and wages don’t, well…OB clients know what that means.

Unfortunately mortgage-backed security prices have not done well relative to Treasury prices in recent weeks. Put another way, the mortgage basis took a beating as realized rates volatility picked up again. But current rate levels are supportive for demand from domestic and overseas yield-based investors and a steeper curve supports CMO (collateral mortgage obligation) based demand for MBS. The supply for agency MBS should also drop significantly as the refinancing activity has collapsed and the peak for purchase apps are behind us. And this will counteract some of the rate move.

In the last few weeks we’ve been reminded that, other things being equal, our bond markets and interest rates are greatly influenced by what happens overseas. To the extent that Greece makes progress in righting its financial ship, our rates will creep higher. But if there is uncertainty and drama, we can all look for a continued flight to quality keeping our rates in check.

Residential lenders, including both banks and mortgage banks, tend to be a nervous lot. This is easily understandable. Just like farmers, who usually have too much rain or not enough, or are dealing with fewer crops when prices are good or an abundance of crops when prices are down, Optimal Blue clients have plenty of concerns. Some of these can be managed while others cannot.

One concern which is entirely out of the industry’s hands is the state of the economy, and therefore rates. In the last few weeks rates have slid higher as the economy is showing signs of picking up, and it is a good idea for OB clients to know why rates have crept up.

Last week’s holiday-shortened week saw first quarter GDP revised down minus .7 percent compared with an initial reading of plus 0.2 percent. A bigger negative contribution from net exports was one of the factors behind the revised contraction. However, the economy is expected to improve in the second quarter because of better than expected economic data for the second quarter months. Yet many lenders, including OB clients, continue to question the numbers: they just aren’t seeing the economy rolling along.

Last week, all major indices finished in the red due to mixed economic indicators. The S&P closed at 2,107 while the Dow ended the trading week at 18,010. In major economic indicators released last week, Durable Goods Orders were down for the month of April but Goods ex transportation were up. Strength in nondefense capital goods excluding aircraft reflects strength in business investment which has been soft of late. The housing sector saw some good news last week. For the month of April, New Home Sales came up strong at 517,000, up 6.8 percent. Pending Home Sales jumped a much higher than expected 3.4 percent in April following a revised 1.2 percent gain in March. Also, for the month of March, the FHFA house price index rose a lower than expected, 0.3 percent.

But overall, it looks like the recovery in the housing market is finally getting some traction. Once again, however, OB clients in various parts of the nation are seeing different stories. In urban areas there is no inventory. In the suburbs there is more inventory, but things are slow in many areas.

Moving on to the bond markets last week, Treasuries saw some demand due to mixed economic data, some weakness in equity markets, and uncertainty over Greece’s debt negotiations. At the end of the week the 10-year note settled at 2.12 percent down 9 bps from the previous week. Towing the same line, conforming mortgages rates also loosened up a bit. At the end of the week the Conforming Fixed 30-year rate leveled out at around 3.67 percent, while the Conforming Fixed 15-year rate finished at around 2.90 percent.

This week, investors are already busy tracking the latest developments on the Greek debt situation as well as digesting a busy economic calendar. We did have a spate of news upon which to chew Monday – most of it showing that the economy continues to book along and thus nudge rates higher. We learned that Personal Income was +.4% in April while spending was flat. PCE, a measure of inflation, rose 0.1% over the prior month and 1.2% over the prior year on a “core” basis. Construction Spending was +2.2% in April, creeping above $1 trillion – up about 5% versus a year ago. ISM Manufacturing showed that economic activity in the manufacturing sector expanded in May for the 29th consecutive month, and the overall economy grew for the 72nd consecutive month. And when you combine all that with a glob of $25-30 billion in corporate debt supply hitting the market, well, rates went up.

We will have the Employment Report on Friday – something that the press always focuses upon. Overall it seems the economy is doing okay – but time will tell, of course.

The old saying is that “no tree grows to the moon.” Anyone renting, or hoping to purchase their first house, is hoping that adage is true sooner than later. Most indices show that home prices keep rising, but sharply declining homeownership means less and less households are benefitting. And the divergence highlights the transmission challenges faced by the Fed and why hiking rates is necessary, but hard to justify. And what does it mean for Optimal Blue clients?

So home prices and rents are up, and homeownership is down. Most of OB’s lender clients agree that not everyone deserves to borrow money and/or own a home. Home prices and rents keep rising, but sharply declining homeownership means less and less households are benefitting and more and more households are being priced out of homeownership and forced to pay higher rents. Similarly, home prices are up by 25% from the bottom in December 2011, while personal income has only grown by 13%. In the past (think housing bubble/crisis), large divergences between home price growth and income growth had disastrous consequences. And OB clients and the industry certainly don’t want that.

At the moment most experts don’t think that disaster is looming, but the divergence is at least cause for concern, particularly for the Fed, who has pursued an asset/real estate inflation policy for the past six years. The Fed may feel compelled to rein in home price inflation but, at the same time, acknowledge 1Q GDP was a bust for more than just transitory reasons and take note, at least tacitly, that the economic surprise index is hovering at the lowest levels since mid-2012, just before QE3 was rolled out.

Rising home prices have the positive effect of increasing household wealth, but the higher prices also have the negative effects of creating affordability problems and putting housing out of reach for a larger share of households. And so LOs are seeing that the declining rate of homeownership means that less and less households are benefitting from the post-crisis rise in home prices. Moreover, the combination of higher home prices and declining homeownership is driving up rents for those boxed out of homeownership. Read: Millennials in urban areas like San Francisco, Denver, and Seattle.

Home prices have certainly been helped by lower rates. The Case Shiller national home price index was up 4.2% year over year and is now up 25% from the low in December 2011. Over the same timeframe the Census Bureau reports that median asking rents are up by 12%. Meanwhile, the homeownership rate continued its sharp decline, dropping to 63.7% in 1Q 2015 – the lowest rate since 1988. Someone needs to tell Bill Clinton! Since the low in home prices in December 2011, the homeownership rate has dropped by 2.3% on an absolute basis.

The divergence between the two since December 2011 is striking. In the pre-crisis era, when credit flowed freely, rising homeownership was followed by rising home prices, which in turn was followed by more increases in homeownership. We all know how that story ended. In the post-crisis era, where credit is tight, the feedback loop has been eliminated. Rather than fueling homeownership, rising home prices are having the opposite effect: reducing affordability and forcing households out of the ranks of homeownership.

So many experts are predicting something has to change: rent increases will stop, housing prices will drop, or incomes will catch up. Each one will impact the economy in different ways, and each one has different implications for OB’s client’s business models.

Capital Markets staffs at Optimal Blue clients are sometimes asked, “Why are there different securities for Fannie loans versus Freddie loans? And while we’re talking about this, why have different mortgage-backed securities for all the different programs – couldn’t they be combined into one MBS?” That is a legitimate question, and in fact the agency that oversees Freddie and Fannie – the FHFA – is moving in exactly that direction. And it is a good thing.

The FHFA released its Progress Report on the development of the single GSE (government sponsored enterprise) security detailing the progress made since FHFA requested comment on the effort last year. All parties involved know that this is a multi-year project with lots of moving parts involving both the primary markets (differences in DU and LP, differences in documentation and credit quality, and so on) and in the secondary markets (reps & warrants, payment processing, handling delinquencies, investor reporting).

Progress is being made. It has been determined that each Enterprise (read: Fannie & Freddie) will issue and guarantee first-level Single Securities backed by mortgage loans that the Enterprise has acquired. The Enterprises will not cross-guarantee each other’s first-level securities. And the Federal Home Loan Banks will not be an eligible issuer of Single Securities.

The key features of the new Single Security will be the same as those of the current Fannie Mae Mortgage-Backed Security (MBS), including a payment delay of 55 days. And these First-level Single Securities will finance fixed-rate mortgage loans now eligible for financing through the “To-Be-Announced” (TBA) market, and this includes Multiple-Lender pools. Lenders will continue to be able to contribute mortgage loans to multiple-lender pools. The loan- and security-level disclosures for Single Securities will closely resemble those of Freddie Mac PCs.

Each Enterprise will be able to issue second-level Single Securities (re-securitizations) backed by first- or second-level securities issued by either Enterprise. The report reads that, “In order for a legacy Freddie Mac Participation Certificate (PC) to be re-securitized, the investor would have to first exchange the PC for a Single Security issued by Freddie Mac, so that the payment date of all of the securities in the collateral pool backing the re-securitization would be the same. To clarify the counterparty risk posed by commingled re-securitizations, this Update provides an analysis of the counterparty risk exposure of investors under the Enterprises’ current securitization programs and the Single Security.”

What about when loans go bad? There isn’t much change. “Current Enterprise policies and practices related to the removal of mortgage loans from securities (buyouts) are substantially aligned today and will be generally similar and aligned for purposes of the Single Security.”

All in all there are sixty pages of updates, and as was mentioned at the beginning of this write up it will take years to sort through. One of the goals is to continue to make progress with issuing a single security while at the same time minimizing market disruption. For example, no one wants an investor – let’s say a bank in Japan – to have paid a certain price for a U.S. MBS only to have it plummet in price due to a change in its structure.

As a reminder, the goal of the single security project is to increase secondary market liquidity by allowing the GSE securities to be fungible for purposes of TBA delivery. Hopefully a single mortgage-backed security (versus F&F issuing separate bonds as they have always done) by both firms could reduce homeowners’ borrowing costs. And wouldn’t that be nice to be able to say.

Optimal Blue clients know that without an investor for securities backed by mortgages, or the mortgages themselves, there would be no demand for that asset. And if there was no demand in the secondary markets then there would little reason for a lender to offer a program to borrowers. And so lenders are keenly aware of changes to agency guidelines for products, both from Fannie & Freddie but also from the FHA & VA. They don’t provide a secondary market for the loans, but their programs do dictate the characteristics of the loans entering the pools.

So it is good to remind our clients of some upcoming changes: the FHA is changing some of its underwriting guidelines effective June 15th (applicable to loans with case numbers assigned on or after that date). Some of the changes are favorable and some are less favorable. Those in the primary market (LOs, processors, and underwriters) know about them, and it is important for others as well since they will change the loan characteristics.

Let’s start with “deferred obligations.” Under the current rule, loans deferred more than 12 months from closing do not have to be counted in the DTI ratios. Under the new rule, which most view as unfavorable, all deferred obligations, regardless of when they will begin must be included in the qualifying ratios. The lender must obtain evidence of the deferral, the outstanding balance, the terms of liability and the anticipated monthly payment. If the actual monthly payment is not available for installment debt the lender must utilize the terms of the debt or 5 percent of the outstanding balance to establish the monthly payment. For student loans, if the actual monthly payment is zero or is not available, the lender must utilize 2 percent of the outstanding balance to establish the monthly payment (this change for student loans will bring FHA’s guidelines on par with conventional loans).

Another change – mostly favorable – is for installment debt. Under the current rule, installment debts lasting less than 10 months must be included in the amount of the debt and will affect the borrower’s ability to pay the mortgage during the months immediately after loan closing, especially if the borrower will have limited or no cash assets after loan closing. In the new rule that goes into effect next month, closed-end debts do not have to be included if they will be paid off within 10 months if, cumulative payments of all such debts are less than or equal to 5 percent of the borrower’s gross monthly income. The borrower may not pay down the balance in order to meet the 10 month requirement. Of course the “work around” is to pay the car down before the credit report is pulled.

Moving on to revolving debt, under the current rules if the credit report shows any outstanding balance, but no specific minimum payment, the payment must be calculated as the greater of 5 percent or $10.00. Under the changed rules – also viewed as favorable – lenders are focused on the section that deals with 30 day accounts (like American Express that has to be paid off monthly). Thirty day accounts that are paid monthly are not included in the DTI, if the credit report reflects any late payments in the last 12 months, utilize 5 percent of the outstanding balance as the borrower’s monthly debt to be included in the DTI. The lender must use the balance on the account monthly for the previous 12 months and document the balance. Additionally, the lender must document sufficient funds are available to pay off the balance as well as meet reserve requirements and funds needed to close the loan.

We realize that this is a little “in the weeds”, but it is important for our clients to see the trends in agency production – especially when they impact both the primary and secondary markets.

What the heck is “CRT”? Is it yet another acronym in a sea of acronyms that make up mortgage banking lingo? Well, it is an acronym, but it is important for Optimal Blue clients to know what it is, since the demand for securities backed by mortgages directly impacts rate sheet pricing and programs in the primary markets.

Back in 2013 Freddie Mac announced a new bond that sells off some of the default risk of its residential mortgage holdings to private investors willing to gamble on its pool of loans. This is something that the FHFA has been encouraging both Freddie and Fannie to do: share the risk on $30 billion each of their portfolios and try to bring more private capital into the markets.

The so-called “risk-sharing” residential mortgage-backed securities (RMBS) were marketed to investors. The Structured Agency Credit Risk (STACR) bonds sell some of the risk of future losses on pools of residential mortgages to investors. Those mortgages underlying the “stackers”, as the bonds have come to be known in the industry thanks to their acronym, were all originated in the third quarter of 2012.

“Freddie Mac Structured Agency Credit Risk (STACR) debt notes are unsecured and unguaranteed bonds issued by Freddie Mac whose principal payments are determined by the delinquency and principal payment experience on a STACR Reference Pool consisting of recently- acquired single family mortgages from a specified period. Freddie Mac transfers credit risk from the mortgages in the Reference Pool to credit investors who invest in the STACR debt notes. Freddie Mac makes periodic payments of principal and interest on the Notes, and is compensated through a reduction in note balances for defined credit events on the Reference Pool, based on a fixed severity approach.”

So generally speaking Freddie Mac, for example, holds the senior-most risk in the deal as well as the first-loss pieces. Even though Freddie Mac is currently government-run, it could take losses on the transaction. Some of the triggers potentially causing such losses include loans that become 180 or more days delinquent, or the occurrence of a short sale prior to the 180-day delinquency. The deals generally have a senior/subordinate structure, with principal paid pro-rata between senior and subordinate classes, meaning that all tranches receive their proportionate shares of principal payments during the life of the securities.

So how are things going? Freddie Mac recently upsized and issued its first actual loss CRT (credit risk transfer) deal. The deal was issued on seasoned collateral vs. other recent stepped severity deals. Prices on GSE CRT bonds have done well due to strong demand for the new issue actual loss deal.

What does all this mean? What investors will pay for these bonds, just like any other fixed income security, depends on several factors including the direction of rates, the chance of losing money, and the liquidity of the instrument. In the case of these securities that prices have done well for those very reasons. Houses are appreciating which limits losses from delinquencies and foreclosures, interest rates are steady, and as more bonds are issues we can expect the liquidity to only increase.

Investors are keenly interested in increasing their returns, and if these bonds are viewed as safe and liquid while at the same time offering a better yield than alternative fixed income bonds, then that is a good thing for the markets. And in turn for borrowers in general.

Optimal Blue clients know that rate sheet prices are basically composed of security prices, loan-level price adjustments, servicing values, and profit margins. So it of interest when any of those change much, and by choice, so folks took notice when the FHFA announced the completion of its review of the guarantee fees (G-Fees) charged by the GSEs. FHFA found “no economic reason” to alter the baseline G-Fee; however, it has ordered the removal of the 25bps Adverse Market Delivery Fee and the targeted adjustment of fees charged for certain loan types.

And so the comprehensive Fannie Mae and Freddie Mac guarantee fee review is finished, and it looks like not much is going to change. The 25 basis point adverse delivery fee is gone, but there are new fees imposed, so it looks to be more or less a wash. Borrowers with lower credit are going to pay slightly less, while high balance investment properties & cash-out refis will become slightly more expensive.

Borrowers with weaker credit will pay slightly lower fees, while most others will see prices remain the same. Certain riskier loans, such as those on investment properties, those over $417,000 and cash-out refinances will become incrementally more expensive. “The FHFA has determined that current fees, on average, are at an appropriate level,” the agency said in a statement. Even with the changes, fees on average remain about twice 2009 levels – and we all remember the increases under Ed DeMarco meant to crowd in private capital. Watt is repudiating, in some measure, that approach.

The companies will eliminate an “adverse market” fee of 25 basis points that they began charging all borrowers after the financial crisis. They’ll raise fees by the same amount for borrowers with credit scores above 700 and at least 20 percent equity in their homes, meaning the changes will be a wash. Borrowers with weaker credit or less equity won’t see an increase, so their payments will fall by 25 basis points. Mortgages over $417,000 will go up 25 basis points, and some higher-risk loans will increase 37.5 basis points.

The 25 basis point AMDC will be removed for all loans, but offset by 25bp increase for <80 LTV, >700 FICO loans, effectively leaving their LLPAs unchanged for those borrowers. This leaves only >80 LTV and <700 FICO borrowers with a 25bp reduction. Approximately 41% of conventional issuance falls under this criteria. The equivalent rate decrease for these borrowers is about 5 basis points. Investor, Jumbo, cashouts and those with secondary financing see their LLPAs increased 37.5bps (about 7bps rate equivalent increase). For TBA securities – used by plenty of Optimal Blue clients for hedging and delivery – the cheapest to deliver loans fall into the <80 LTV > 700 FICO bucket so there should be no impact. The market was pricing in a possibility of higher LLPA reductions so the announcement should be supportive of higher coupons.

For jumbo conforming product the 37.5bps LLPA increase stands to raise borrower costs by 7bps resulting in a 2-4 CPR decline in speeds. Model estimates indicate upside up to a quarter point, especially in 3.5s and 4s.

Analysts say that these changes reflect a highly market sensitive and gradualist regime at the FHFA, in contrast to broader market concerns about Watt’s new leadership. It appears that there are limited policy options to lower borrowing costs given lack of GSE capital. Starting in September there will be modestly higher borrowing costs for a handful of better-credit borrowers and modestly lower costs for marginal credit and leveraged borrowers. One thing it does, however, is remove uncertainty as to what may happen with Agency pricing – and that is a good thing.