We received the monthly GSE data download for the June book of business over the weekend and prepayment speeds dropped for the second consecutive month, with the 1-month CPR printed 22.4, the low posted since 17.1% was reached in February 2020 just before the onset of the pandemic.
Mortgage rates are of course the key driver here, but other issues matter as well, notably lending capacity. With the onset of the pandemic and the associated loosening of monetary policy and spike in demand for housing away from dense locations, the mortgage industry became overwhelmed. Originators were busy hiring and increased their capacity over the past 18 month to deal with the long period of refinancing activity. However, as prepayment speeds slow down, it appears that the capacity building may be overshooting. In response, originators have started to lower their underwriting standards to create enough volume to fully utilize the capacity.
Traditionally, the industry fine-tunes its production through tweaking its credit standards to keep its pipeline as full as possible. This is occurring now notably for refinance mortgages:
What we can see is that purchase demand remains strong, with the swing product being refinance mortgages. It is evident that lenders are trying to smooth out refinance production with countercyclical credit tightening and loosening. As credit scores are higher than was the case in the pre-pandemic period there is room to ease further, but the ultimate extent is highly uncertain.
As we have commented several times, the Federal Reserve Z.1 data is a fine source of information on long-term financial market trends. This post looks at trends in ownership of single-family mortgage risk. The chart below shows this distribution from Q1 2007 to Q3 2020:
The role of the Federal Reserve in the mortgage market is an ongoing theme in this blog, dating back to the early days of the Covid-19 crisis. Besides the level of short-term rates, when we think about the Fed, we consider its direct intervention through the outright purchases of MBS. A common view of this “QE” policy can be seen in charts such as:
In a previous post, we noted that a key component of the implementation of unconventional monetary policy is the selection of coupons in its MBS purchase programs. As coupons in these securities occur only in steps of 0.5%, obtaining liquidity in new lower coupons is important in establishing a basis for mortgage rates to move lower. For example, 2.5% 30-year coupons were issued in 2013 and 2016, but never to the extent that liquidity was firmly established, limiting declines in the rate that borrowers paid at those times. This changed dramatically with the onset of the Covid-19 crisis. In March 2020 the Fed restarted its MBS purchase program after six years, including the 2.5% coupon, and this soon became the dominant coupon.
Since that time, the Fed has picked up its activity on this front. The GSE’s started issuing 2.0’s shortly after the crisis hit, and the Fed began buying them in May. Then 1.5% came on the scene this summer and this week sure enough the central bank validated this activity by adding them to their portfolios.
Can 1.0’s be far behind?
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.
April mortgage deliveries by the agencies Fannie Mae, Freddie Mac and Ginnie Mae showed a rise in deliveries of mortgages to the two agencies for both home purchases and refinances. Purchase mortgage volumes reflect a normal seasonal pattern, while refinances experienced a sharp spike upwards in response to low levels of interest rates. Given normal (and possibly growing) lags related to closing times, many of these contracts were signed in March when rates had already dropped sharply but the full impact of the Covid-19 virus on stay-at-home policies was not yet fully felt.