While the single-family housing market is booming, the trend in the multifamily market is much more nuanced. Over the 3 ½ year period from July 2017 to December 2020, new supply as measured by housing starts was in a steady-to-modestly rising trend. This changed with the onset of the Covid-19 pandemic:
In prior posts, we have pointed out the tight relationship between unemployment and mortgage delinquency. This note extends this analysis by looking at this relationship at particular durations.
Every month, the Bureau of Labor Statistics releases data on the “Duration of Unemployment”. For example, below find a table containing data for the number of unemployed people in before, during and after the shock associated with the onset of the Covid-19 crisis by how long they have been unemployed.
As we head into 2021, an ongoing issue is the disposition of loans in forbearance. The Cares Act allows for borrowers negatively impacted by the Covid-19 pandemic to obtain forbearance up to 1 year. This will begin to expire in Spring 2021, although an extension is possible as the new Administration takes over in January. A key point is that forbearance is not forgiveness. The mortgage agencies have provided options for borrowers who become current after forbearance, so they don’t have to make a lump-sum payment for missed principle and interest.
FHA has designated its policy regarding the disposition of suspended payment amounts as COVID-19 National Emergency Standalone Partial Claims(COVID Partial Claim).
“The COVID Partial Claim puts all suspended mortgage payment amounts owed into a junior lien, which is only repaid when the homeowner sells the home, refinances the mortgage, or the mortgage is otherwise extinguished.”
Unlike the situation during the Global Financial Crisis, imbalances in the housing market are not the root cause of the Covid-19 economic downturn. Instead, housing is helping to pull the economy out of its pandemic-induced swoon. House price rises have accelerated, due both to low interest rates, as well as to household relocations away from high-density areas. This is leading to increased construction, and improved household balance sheets. Moreover, a surge in refinances improves household cash flow. How long can this trend continue?
The answer to this question depends crucially on many varied policy settings that influence lender and borrower behavior. The chart below shows 1-month CPR for 30-yr MBS securities broken down between the 30-Year GSEs and 30-Year FHA for the 2017cohort. A number of fundamental and policy factors come into play.
One of our ongoing themes in this blog is that we are entering a period of unremitting structural change. We’ve noted previously that the combination of Covid-19 and technological innovation is leading to a surge in the nonbank share of purchase mortgages to the GSE’s. Of course, there are others, notably climate change. As the technology leader among states and also the one suffering severe damage from wildfires, California is at the nexus of these transformations.
A survey conducted by the University of California at Berkeley in 2019 revealed that more than half of the residents of the state had given “some” or “serious” thought to leaving the state. Has this in fact occurred? Such a desire may be offset by the traditional role of the state in attracting immigrants and young people looking for careers in technology and media. One way to look at this is to pull data for the count of new purchase mortgages sold to the GSEs in the state as a share of the US total:
The Federal Reserve recently released its quarterly Z.1 report: The Financial Accounts of the US (formerly known as the Flow of Funds) for Q2 2020. This voluminous dataset contains very detailed information describing financial flows and stocks across all major segments of the economy. For our purposes the key chart is the distribution of holdings of Total Long-Term Agency Debt (Agency MBS + Agency notes and bonds):
The clear takeaway for Q2 is the central bank gained share as it took unprecedented actions to stabilize the financial system in the wake of the Covid-19 crisis. The Fed’s share of the stock of Long-Term Agency Debt jumped by about 4.9% from Q1 to Q2, a record high increase. The biggest losing category was “Others” which fell by 3.6%. This loss came largely from the household subsector within this category. The “Commercial Banks” share rose by 0.9%, but this does not necessarily imply greater appetite for mortgage risk as depositories are increasing their securitization rate by swapping whole loans for securities. Finally, the “Foreign Investor” category lost 0.5% to a 7-quarter low.
The Covid-19 pandemic has resulted in a great economic shock that has been met with a tremendous policy reaction in the form of interest rate cuts and MBS purchases by the central bank. Prepayments have picked up substantially during the year. The question arises as to whether the magnitude of the response is unusual compared to previous episodes of rate declines, and whether they can rise further should borrowing costs fall further.
The magnitude of the relationship between rates and refis is complex and depends crucially on a number of factors. First, the relationship is path-dependent. That is, it doesn’t just matter if rates fall 1.0%, but whether this decline takes rates to new lows so that the biggest possible set of borrowers can profitably refinance.
Great gobs of sophisticated statistics and modeling go into forecasting prepays on the part of lenders and investors. But a look at prepays over time shows three main waves of refis over the past 20 years. The first (A) is 2000-2003, (B) 2008-2013, and (C) 2019-2020. In all three instances, rates reached new lows. The dates correspond roughly to the times when the mortgage rate broke to a new low until a new trough was formed (or the present in the case of “C”)
Here are the corresponding periods for prepays:
Here are the corresponding periods for originations:
Here is a summary of the three periods:
Notably, the biggest jump in prepays occurred in the early 2000s, reaching a record high of 60 CPR. Rates had fallen substantially based on aggressive Fed ease in the wake of the bursting of the tech stock bubble. This passed right through to refis. There was also a substantial decline in rates with the Global Financial Crisis(GFC), but the refi response was more muted due to declining house price, but perhaps also more stretched out in time (off and on through 2013). The current episode with Covid-19 has resulted in record-low mortgage rates, and a substantial spike in refis, but still well below the experience of 2002-04.
What might explain the differences? A clear place to look is at credit conditions. If rates drop the same amounts in time periods X and Y, but credit conditions are tighter in Y than X, we can reasonably expect a bigger refi impact in X than Y. Below shows the Urban Institute’s Housing GSE Credit Availability Index, which is used to evaluate lender’s risk tolerance:
Note: Urban Institute’s Housing Credit Availability Index for GSE Chanel. Adapted from Urban Institute Housing Finance at a Glance (August 2020). (https://www.urban.org/research/publication/housing-finance-glance-monthly-chartbook-august-2020)
As can be seen, credit was extremely loose before the GFC, very tight thereafter, followed by a period of modest loosening until 2019. This correlates well with the magnitude of the response of prepays to interest charges in the three regimes. Too hot, too cold and just right? Maybe.
All of this is important not just for investors but for the central bank as the Fed attempts to steer the economy through this uniquely uncertain period. Recently, credit conditions appear to have started tightening. It’s unclear whether this is a “normal” market reaction as volumes rise and capacity is constrained (good credits are easier to process) or whether lenders are becoming more cautious based on a more pessimistic view of the economic outlook. There is a big difference between the two in terms of choosing a successful investment strategy or an optimal monetary policy. The answer is unlikely to come from attempts to model borrower and lender behavior in a nuanced way and more likely to be discerned by careful observation of emerging trends in big data sets.
We have commented previously on the rising share of nonbank deliveries to the GSE’s in the wake of the Covid-19 crisis, but the data just released for the month of July shows this trend to be picking up at an astonishing pace. This time, let’s break the market up into two pieces: Purchase and Refi: