The government-sponsored enterprises, Freddie Mac and Fannie Mae, have triggered an increased number of buybacks this year as they process the loans sold during and after the pandemic-initiated purchase and refinance boom. The timing couldn’t be worse, with these extra expenses coming while lenders’ pockets are already thin. Too many repurchases can spell disaster, especially for smaller lenders. But this impact isn’t felt only at the corporate level — these buybacks impact individual originators too.

“When any lender puts credit restrictions onto their business model, it is the least represented borrower that first gets impacted.”

Taylor Stork, president, Community Home Lenders of America

If you’ve noticed increased calls from confused former clients, you’re not alone, says Taylor Stork, a longtime originator and president of the Community Home Lenders of America (CHLA). When a loan is repurchased, it changes hands at least once, if not twice, and usually changes servicers. This triggers a flood of “hello” and “goodbye” letters to the borrower, who is likely to call their mortgage originator for help figuring out where to send payments.

As the originator, you’re unlikely to know what’s going on and will have to dig for information. If you’re a broker, Stork says, it’s likely you won’t be able to get any information at all, since you’re not privy to the transaction and it’s protected by information security rules.

“(Clients) expect me to make sure that they are taken care of all the way through the process,” Stork says. “For originators, it creates a tremendous amount of confusion. It certainly tarnishes the relationship that we have with our customers and with our referral sources.”

There’s an impact on the originator even before the buyback happens, says Brendan McKay, president of advocacy for the Association of Independent Mortgage Experts (AIME). Before a buyback goes through, the loan is audited. This often means requests to the originator for additional documents from the borrower, sometimes months or years after closing.

The GSEs argue that these loans don’t meet their quality standards, with Freddie Mac citing miscalculated income and missing documents as the two leading causes of buybacks. But lenders and mortgage advocacy organizations argue that many are returned to the lender for minor issues on loans that are still performing well. “These are not bad loans,” Stork says. “These are good loans that may have little, tiny technical errors.”

Often, the repurchase request is not even due to error. “A lot of these, as we’ve gone through them, have been [due to] appraisals,” says Scott Olson, CHLA’s executive director. “People had two appraisals. They both are fine and (the GSEs) are claiming, ‘No, we disagree.’ … It’s just a difference in judgment.”

A lender being forced to take back a performing loan may not seem like a dangerous prospect, but lenders often aren’t equipped to hold loans on their balance sheets. This means they must resell the loan after the buyback, and most lenders turn to what McKay terms the “scratch and dent” market to do so. Loans sold this way incur massive losses for the lender. And this puts smaller lenders at higher risk of default since the losses on only a few buybacks can make a huge difference on their balance sheets. “Getting a loan bought back is absolute misery,” McKay says.

These costs averaged 8 basis points per loan in 2020 before rising to 68 bps in 2023, according to McKay. “That cost, if it continues, is getting passed along to the loan officer and the consumer,” he says. “All of us are going to have worse rates. That’s why originators should care about this.”

Stork says the natural response by lenders and originators is to tighten qualification standards in an attempt to bulletproof the loans and prevent them from being bought back. “When any lender puts credit restrictions onto their business model, it is the least represented borrower that first gets impacted,” he says. “Buybacks result in a tightening of the credit box.”

This past October, the Federal Housing Finance Agency (FHFA) tweaked its buyback policy for loans subject to COVID-19 forbearance. It also reported that GSE repurchase requests have passed their peak, with buybacks now trending downward. But there’s still work to be done.

The CHLA has called for the ceasing of all pandemic-era repurchase requests that aren’t tied to fraud, if the borrower is current on their payments. AIME has called for refinement of the buyback policy, as well as increased transparency and consistency around its enforcement. The FHFA said in October that the GSEs must implement a “fair, consistent and predictable process.” The eventual goal is to create less ambiguity in underwriting, which should reduce buybacks in the long term.

Buybacks are important for originators to understand because they’re on the frontlines and are likely to deal with the fallout. These include a tighter credit box, loan audits and more document requests. In the most dire circumstances, lenders could lay off staff or fold.

“They need to understand their responsibility in helping to protect the industry, whether for everyone’s good or their own good,” McKay says. “This type of pain doesn’t exist in a vacuum. It’s going to get shared by everybody.” ●

The post Loan buybacks are harming the mortgage landscape appeared first on Scotsman Guide.

The post Fix-and-flip profits grew, but the trend bears watching appeared first on Scotsman Guide.

Home’s changing role

Experienced mortgage lenders will understand the project itself — beyond the budget — and can assess its likelihood of success while providing guidance.

A good partner

New product arsenal

The post A Fruitful Investment appeared first on Scotsman Guide.

Shifting market

Operational assessments

The post These Mortgage Trends Are Becoming Clear appeared first on Scotsman Guide.

Rural America’s moment

Know what to avoid

The post The Fix-and-Flip Trend Goes Rural appeared first on Scotsman Guide.

The truth is that if a loan file meets a bank’s underwriting requirements, the bank will almost always fund the loan. But what happens when the borrower or the property (or both) is outside of the bank’s often narrow criteria? The solution to this dilemma may be a lesser-known lending system that exists parallel to the ubiquitous banking system. It’s called hard money lending, and it can offer real solutions for brokers and their clients.

The basics

In general, hard money loans are high-interest, short-term bridge loans that are primarily used in real estate transactions. These loans are offered by companies and high net worth individual investors. Just like in the banking universe, hard money lenders use the same contracts, mortgages, liens, titles and title insurance. This type of lending, however, is usually based on a borrower’s real estate equity, not on their credit or income.

Pricing varies on a nationwide basis, but on average, hard money loans demand 10% to 12% interest rates, plus several points in loan fees for a six- to 12-month term. The loan-to-value (LTV) ratio averages about 65% and the loan-to-cost ratio is about 75%. Loan fees and closing costs can often be included in the loan amount. Many of these lenders will offer an interest reserve of three to six months through the loan proceeds when the LTV allows. And they can close a loan in a matter of days as opposed to weeks or months at the average bank.

Some borrowers will no doubt find hard money loans to be expensive. But this is opportunity money. With the flexibility and speed of hard money, a mortgage broker’s clients will close more loans and flip properties much more quickly compared to bank loans. And it’s opportunity business for the mortgage broker: If the borrower makes more money, the broker makes more money.

Typical hard money loans are used to help pay for such projects as a fix-and-flip on a single-family investment home. For new real estate investors, these projects are relatively affordable and easy to understand, and they have the broadest buyer base for the finished products.

While some borrowers on these projects will qualify for loans from a bank or credit union, others may not for a number of different reasons — including low credit scores or too many bank loans on other projects. This is where hard money lenders can ride to the rescue. Even borrowers who qualify for a bank loan may choose to work with a hard money lender due to the quick closing and fast access to cash.

The right fit

Borrowers seeking alternatives to banks may find national hard money lenders that can meet their needs. But they also should look for small, local lenders that are active in nearly every town across the country. Many of these lenders are individuals who are experienced with helping entry-level fix-and-flip borrowers. They may be commercial real estate brokers, title company employees, attorneys or even retired bankers.

Local lenders will know the surrounding market better than any national lender because they live and work in it every day. And they’re eager to do business. They will move quickly to meet and talk with a borrower, then view the property. Often, they’ll make a loan offer that day, if not that hour.

Finding these local lenders, however, may take some work. The larger players in this field can often be found online or at real estate conferences in the area, but smaller lenders without websites may require some sleuthing. A good place to start is with a state’s online business records. Many states offer downloadable and searchable lists of registered mortgage lenders. The secretary of state’s corporations division, or the local equivalent, is another great source.

Another method for mortgage brokers is to simply call and ask local title and escrow officers, residential and commercial real estate brokers, and attorneys who specialize in real estate issues for any hard money lenders they may know. It pays to be nice in this business, so mortgage brokers should always be sure to provide some value to these sources. Make a gesture such as offering to distribute their business cards to clients. Acts of kindness may help ensure that a broker will receive a referral.

Meet and greet

When first reaching a hard money lender on the phone, the lender is bound to ask how the caller found them. Be prepared if they want specifics. Some private-money lenders emphasize the term “private.” Give credit to anyone who may have helped along the way.

Once you’re past the introduction stage, be sure to ask about the loans that the lender likes to make. Find out which property types, locations and loan amounts the lender prefers. Always take notes.

Private mortgage lenders tend to be successful, savvy and hardworking. They don’t like having their time wasted, so be honest. Never try to sell them on a deal or attempt to “warm them up.” Stick to the facts. The lender will want to know the story behind the deal, so include a brief, clearly stated and typed narrative with only the facts. Never state anything that can’t be backed up with documentation.

If a broker truly wants to be successful in this niche sector, they should be sure to visit these properties before sending out loan proposals. Hard money lenders consider brokers who investigate the properties beforehand as more knowledgeable and more motivated to make deals.

These are equity-based deals, so lenders are most concerned with the property’s condition and value, and the borrower’s ability to complete the project on time and as planned. The LTV equation and exit strategy will be the keys to closing such loans.

Know the lender

The more that brokers learn about hard money lenders, the better they will be at targeting the right loan to the right person. Some lenders may not always have funds available to make a deal, no matter how well it fits their parameters. This is why brokers always need to know more than one lender.

A loan made by a bank is a small part of its total asset value. But any loan made by an individual hard money lender is a large portion of the person’s net worth. Understandably, they are more particular about location, property type and the borrower. For instance, if a lender makes a loan on a coffee shop and doesn’t get repaid, they may never make a loan on a coffee shop again, no matter how good the next proposal is.

Hard money lenders rarely need as much paperwork as banks, so a broker should never inundate them with documents. Start with the basics: a clearly typed loan request and a fully completed personal financial statement. Include a schedule of all real estate owned by the client, their credit reports and a current appraisal of the property, if available. Brokers should expect lenders to give them homework. In return, they should provide only the documents that a lender asks for rather than full bank files.

Once the requested information has been sent to a potential hard money lender, brokers can call to ask for an opinion. Brokers should always have their loan summaries in front of them so they can provide the facts and the narrative to the lender in the manner requested. Then they need to be quiet and take good notes on what the lender has to say. If a lender rejects the loan proposal, a broker can find out why and then go back to the borrower to see if the problems can be solved.

Lucrative work

The niche market of hard money lending can be quite profitable. On a bank loan, mortgage brokers usually earn between 50 to 100 basis points (0.5% to 1%) of the loan amount. In the hard money world, this fee generally starts at 100 basis points and may rise to 150 or more.

Fees are paid out of escrow once the loan is closed and recorded. Land, development or construction loans are harder to complete, and may justify charging a slightly higher rate, but a broker shouldn’t get greedy. Demanding 400 or 500 basis points on a single hard money loan could end a deal before it begins.

These fees don’t decrease much as the size of the hard money loan increases, so bigger can be better. And brokering any hard money deal means a faster closing with fewer documents. A simple broker referral should earn about 25 to 50 basis points. But brokers shouldn’t get involved in daisy chains. Some hard money lenders dislike paying for even one referral source, so brokers should try to find their own lenders.

When everything comes together with a solid loan proposal, a reasonable LTV ratio, and a borrower who demonstrates an ability to complete the project before selling or refinancing to pay off the hard money loan, the broker likely has a deal. Hard money lenders tend to want a regular (but attractive) return on their money. They don’t want the property itself. If a broker gets the feeling that a lender wants the property, they should move on and find another funding source.

There are always hard money lenders ready to invest in deals that don’t quite fit the banking box. By connecting the right lenders to the right borrowers, commercial mortgage brokers can help everyone succeed. ●

The post Hard Money, Soft Landing appeared first on Scotsman Guide.

This home-improvement fare does more than entertain. These shows have had a major impact on the home-renovation industry. For one thing, the programs have a tendency to make the renovations appear far easier to do than they are in reality. They also have helped to raise the expectations for just about everyone involved in the home-renovation industry — including fix-and-flip investors, the contractors doing the work and the buyers who eventually live in these homes.

Mortgage brokers should pay attention to this sector of commercial real estate finance. These activities continue to be popular and lucrative for all types of investors and lenders.

Small town, new life

For both veteran and novice fix-and-flippers, the newest area of opportunity is in smaller cities and towns. At this point, big cities have few affordable houses available to the typical investor. The vast majority of these properties are either occupied or are only attainable for high-end homebuyers.

Small cities, towns and villages, however, are becoming increasingly appealing. These rural areas have, for the most part, remained off the renovation radar, and they often include a strong stock of houses that simply need a skilled crew and an investor with an eye for design.

Fix-and-flip or buy-and-hold investors who care about these areas can help turn struggling small towns into bustling, family-friendly communities. Many renovators are embracing the importance of building strong ties with local residents. They’ve learned that these rental properties can be profitable investments as well as safe and comfortable homes for families that otherwise would not be able to afford them.

These areas may lack enough homes for first-time homebuyers, which means that potential new residents and families are lost to neighboring towns. Investors can help reverse this trend of small-town flight by refurbishing single-family homes and rental properties, breathing new life into overlooked and struggling areas that deserve a second chance at success.

As many real estate investors know, single-family homes — especially ones that go to entry-level buyers — are the anchors of any stable and desirable neighborhood. These homeowners take good care of their properties and tend to stick around for more than a few years.

Lending routes

In terms of mortgage financing for these investment properties, borrowers with less experience should explore several routes, from banks to hard money lenders. Beginners may not have the credit scores that traditional banks require, but that doesn’t have to stop them. In fact, traditional banks are often too expensive due to multiple fees, which makes them a less-than-ideal option for loan originators who are serving new borrowers.

Many new investors wind up pursuing creative financing by working with hard money lenders. These lenders are often high net worth individuals who focus on short-term mortgages. They charge higher interest rates but can close deals much more quickly than a bank.

Commercial mortgage brokers also can benefit from the renovation trend by seeking out clients who are skilled fix-and-flippers. Homebuyers make a single home purchase, on average, every 10 to 15 years. Fix-and-flip investors, however, may need financing for multiple deals in a 12-month period for several years running.

Brokers who are able to build solid, long-term relationships with investors also may be able to offer their services to consumer-purpose buyers who end up purchasing the finished flips. It can be a truly symbiotic relationship.

Professional mindset

About 10 years ago, some fix-and-flippers could get away with minimal renovations and shoddy work while still selling their properties for a profit. But this has changed. Many of the people who were only in the home-renovation business for a quick buck have moved on. Today, home flipping is being recognized as a creative endeavor that requires plenty of dedication and elbow grease.

Those who have stayed in the industry have tended to step up their game, evolving into savvy investors with strong design instincts and enviable project-management skills. Many are dedicating themselves full time to the industry. The result is that many modern renovation projects have such high quality that homes wind up looking almost like brand-new construction.

Many structures have new roofs, windows, furnaces, kitchens, bathrooms or granite countertops — all the high-end touches that style-savvy buyers crave. And these aren’t million-dollar houses with unlimited budgets; they’re modestly priced homes in the $150,000 to $250,000 range that are being renovated for the low- and middle-income homebuyer markets.

A more surprising shift among investors is the move away from fix-and-flips to fixing and renting. Once seasoned investors have tackled a few flips, they often decide they’d like to offer these beautifully remodeled properties to responsible renters. Some of them even focus their renovation and rental efforts in blighted areas where they can help turn run-down neighborhoods into friendly, welcoming places.

Retiree renovators

Another emerging trend is the influx of retirees entering the business. While this may start as a fun hobby, some retirees get bitten by the fix-and-flip bug. Many of them recognize that real estate investing is a great way to learn something new, make a difference and earn some extra cash along the way.

These newcomers, however, can find the fix-and-flip process to be quite overwhelming. One of the biggest challenges for a small investor — someone who tackles three to five houses a year — is to find reliable help. The contractor business used to be generational, handed down from parent to child. But this is changing as fewer children are following their parents into the carpentry trades.

The result is that some family-owned contractors are dying off. The ones that remain are often booked for months in advance, making it tough for newer investors to get their renovation projects started.

Another wild card is the rising costs of building materials. With the COVID-19 pandemic disrupting supply chains and employment, homebuilders have seen material expenses skyrocket. Appliances, furnaces and cooling units have experienced drastic price shifts over periods of a few days or weeks, causing new investors to panic over budgetary changes. These inflated prices aren’t expected to last, but it may take time for supply chains to catch up to demand and for labor shortages to subside.

The cost of lumber more than tripled on a year-over-year basis this past spring, adding $36,000 to the average cost of a new single-family home, the National Association of Home Builders reported. Although lumber costs have leveled off in recent months and increased sales prices for finished flips have helped to make up the difference for investors, it’s still been difficult for many in this sector to deal with the fluctuations.

Renovating a home will never be as slick and simple as it appears on TV. But the investors who pay attention and make smart choices will always find a good deal, regardless of who they are, where they live or any challenges the economy may present. ●

The post Great Expectations appeared first on Scotsman Guide.

Despite the sector’s growing profile, however, misperceptions continue when it comes to financing options. Digging deeper into current trends, it’s clear that old assumptions should no longer apply to commercial mortgage brokers and their clients.

The manufactured-housing sector is the only major commercial real estate asset class that has not experienced a year-over-year decline in net operating income in any year since 2000, according to Green Street Advisors. Not surprisingly, a major driver of the sector’s stellar investment performance is that housing-cost increases have outpaced wage increases.

According to the Manufactured Housing Institute, 22 million people live in manufactured or mobile homes in the U.S., occupying 4.3 million sites in about 43,000 land-lease communities. Homes are manufactured in 136 plants across the country and the average sales price in 2019 (excluding land) was $81,900 for the typical 1,448-square-foot home.

A tenant can expect to pay roughly $450 per month for the pad rental, $75 per month for utilities and $500 per month for the home itself. At $1,025 per month, a manufactured home can be a bargain — especially in comparison to the experience of living in an outdated apartment building and sharing walls with neighbors.

In many U.S. locations, manufacturing housing is the only truly affordable, nonsubsidized form of detached housing available. Strong consumer demand coupled with low supply is why MHCs and MHPs have thrived regardless of economic trends — even during the downturn caused by the COVID-19 pandemic. One measure of the sector’s investment strength is that manufactured-housing real estate investment trusts (REITs) have outperformed the broader REIT index over the past several years.

Limited supply

Today, manufactured housing provides shelter for roughly 7% of the U.S. population. This share would likely be much higher were it not for the high barriers placed on new construction.

With the exception of Florida, Texas and Arizona, most states have seen little development of new MHCs or MHPs in recent years. With fewer than 10 new communities developed since 2008, 68% of MHCs were built before 1980, according to valuation company Datacomp. Prone to old stereotypes, municipalities, zoning boards and neighborhood associations often show great resistance to allowing new communities to be developed or expanded.

Contrary to popular perceptions, however, many MHPs and MHCs are professionally managed and offer safe, secure, high-quality housing at affordable prices. Communities often offer clubhouses, swimming pools, off-street parking and other amenities typical of conventional multifamily communities. Furthermore, today’s factory-built homes increasingly resemble stick-built homes, with luxury finishes and architectural details that blend with conventional home designs — and two-story models have entered the market as well. Well-located and maintained communities can be upgraded and improved, and their values are rising in today’s market.

Despite its potential, manufactured housing continues to be subject to misperceptions. There are multiple indications of how far the sector has come.

First, investments in MHCs and MHPs are thriving outside urban centers. Conventional wisdom claims that location in a primary market with relatively high housing costs is fundamental for the success of these properties. Yet what little new MHC development that has been approved by municipalities is underway in rural areas rather than densely populated ones.

One recent deal, for example, is a $9.75 million first-lien construction loan for a new MHC development in Washington state, in a small but lively community about two hours northwest of Seattle. The community, which will have 217 home sites, will be restricted to residents ages 55 and up. The 38-acre property sits in the city’s downtown area and is surrounded by big-box retail, casinos, golf courses, a country club, churches, cafes and outdoors attractions.

Capital sources

Second, numerous financing options are available for these investments. A decade ago, financing options for MHCs were limited because of misperceptions and stereotypes about factory-built housing. But as these types of homes and communities have become more advanced and sophisticated, financing options have flourished.

Most owners of manufactured-housing communities now use commercial mortgages to finance their properties. Some owners are able to secure chattel financing to buy new homes and rent them out, or they can provide seller financing for new residents. Funding sources encompass a wide range of commercial mortgage lenders — including banks, credit unions, debt funds, commercial mortgage-backed securities (CMBS) lenders, family offices, pension funds, life-insurance companies, and even the government-sponsored enterprises Fannie Mae and Freddie Mac.

Agency lenders are often preferred by investors, but other sources finance a significant volume of transactions for factory-built communities. Private lenders are active in many states. REITs, sovereign wealth funds, institutional equity funds and the like also are active in the sector, although some of these lenders prefer larger transactions valued at $10 million or more.

The financing of individual home purchases is, of course, important for MHC and MHP occupancy rates. Specialty finance firms recognize that lending on mobile homes is quite secure, with the loan amounts being smaller than conventional mortgages, but the default-risk profile is similar as the majority of these homes are the occupant’s primary residence.

Some capital sources, however, continue to be more risk averse than others. Not surprisingly, the COVID-19 pandemic has made banks more conservative and has pushed many large banks to the sidelines. Bank borrowers can expect loan-to-value (LTV) ratios in the 50% to 70% range rather than the pre-pandemic levels of 65% to 80%. The typical debt-service-coverage ratio requirement is likely to be close to 1.25 or 1.3 due to the low interest rate environment.

Securitization growth

Even before the pandemic, some lenders viewed this asset class as special-purpose real estate that warrants more conservative terms. These may include lower LTV ratios or personal guarantees rather than the nonrecourse options that investors naturally prefer.

Life-insurance companies, too, often focus on lower LTV transactions and are highly selective with regard to asset quality. The secondary market is seeing increased investor appetite for the asset class, and CMBS lenders continue to offer competitive rates, cash out and long-term nonrecourse loans.

Mortgages for MHCs and MHPs are often securitized, a significant change from previous eras. Over the past decade, however, Fannie Mae and Freddie Mac became the lenders of choice for investors, especially after Freddie entered the sector in 2014.

In 2019, for instance, Fannie provided $2.5 billion in MHC financing while Freddie injected another $1.4 billion, according to Wells Fargo data. As investors in these securities have come to appreciate the performance of MHCs, securitization opportunities have grown to bring more liquidity to the sector.

Favorable terms

Loan terms can be investor friendly. With greater recognition of the MHC sector’s potential, lenders have become increasingly comfortable. Some banks and credit unions, for instance, have a good understanding of mobile-home parks from a credit perspective and will offer aggressive loan terms under normal conditions.

The previously mentioned project in Washington, for example, was funded through a bank-participation loan that covered 69% of the upfront costs. While it is a recourse loan, the five-year term includes a two-year, interest-only period, followed by an amortization period of three years based on a 25-year schedule.

In another recent example, $9.53 million in first mortgages for two MHPs in the Texas markets of Dallas-Fort Worth and Corpus Christi were secured for a repeat borrower. Five years prior, the borrower obtained funding to acquire the two properties and execute a value-add business plan that created a strong position for permanent cash-out financing.

The 10-year, nonrecourse CMBS loans provided by a Wall Street firm feature a fixed interest rate; a three-year, interest-only period; and amortization over a 30-year schedule. Proceeds from the loan were used to pay off a previous loan, cover closing costs and return equity to the borrowers.

● ● ●

Limited supply and strong demand suggest that the outlook for MHC investments will remain positive. This asset class has long suffered from misleading stereotypes and a lack of understanding of the market dynamics for this housing segment, creating constraints on new development. While limited supply sustains the strong investment performance of parks and communities already in place, growing consumer demand points to additional opportunity for investors and lenders to build in the right communities.

Interest rates also continue to be low and the demand for affordable housing has never been higher. For owners, the opportunity to refinance and tap equity to enhance their properties or to buy new ones has never been better. With awareness of current financing trends, savvy investors and commercial mortgage professionals stand to profit while meeting a critical marketplace need for attractive, affordable housing. ●

The post On a Roll appeared first on Scotsman Guide.

Most everything that has happened to the U.S. and global economies in 2020 is a consequence of the COVID-19 pandemic and the associated uncertainty. Gross domestic product or GDP, the sum of all goods and services produced by a nation, dropped everywhere in the second quarter of this year, unemployment rose and the world plunged into a recession.

While domestic media concentrate on what is wrong with the U.S. economy, they tend to miss the point that things are worse elsewhere. According to the World Bank, an international financial institution that lends money to low- and middle-income countries, 92.9% of the world’s economies are contracting. The previous high was 83.8% during the Great Depression. A synchronous recession of this scale has never happened before. In 2020, global GDP per capita will experience its largest decline since 1945.

Concern about eurozone sovereign debt started in 2009 and has never really stopped. Greece, Portugal, Ireland, Spain and Cyprus were unable to repay or refinance their government debt, or bail out banks. By 2013, the effects were significant — unemployment rates in Greece and Spain reached 27%. 

European Union (EU) nations have been adversely affected by COVID-19. Uncertainty about EU sovereign debt is not going away anytime soon. The EU has not made significant policy adjustments post-2009. It has, for example, yet to decide whether a serial defaulter such as Greece should remain a member. 

Developing nations where one can find high yields on sovereign debt have substantial risk. This is reflected in their debt ratings. Four nations have defaulted on their debt, six are very close to default and dozens more are considered troubled. This is based on S&P debt ratings.

The U.S. is the nation that will benefit the most from this. While the U.S. has had a massive increase in both national debt and money supply, interest rates are at historic lows and the U.S. dollar remains strong when compared with the euro. The U.S. dollar is still the world’s most important currency. 

Uncertainty created by COVID-19 will ensure that fixed-income investors seeking safe haven will go to either U.S. Treasury debt, or Fannie Mae or Freddie Mac paper. This likely means that mortgage rates will remain low through the end of 2021.

Investment demand

In estimating where rates will go, attention should be paid to the demand side — the individuals and entities that purchase fixed-income securities. Investors have several choices: equities, fixed-income securities and real estate. 

A point of importance here is that those who are very wealthy are more inclined to not invest in things such as the equity market (mainly the stock market), which has risk. If you have enough to live on for the rest of your life, your only real enemy is inflation, which reduces the future purchasing power of your wealth. A safe thing to do is invest in fixed-income securities, which preserve that purchasing power. These are the people who purchase Treasury debt and mortgage-backed securities. Until the real economy recovers, money will move to safer fixed-income securities (government debt, mortgage-backed securities and high-rated corporate debt) as risk is perceived in equities. While fixed-income securities do not have high yields, what they do have is safety, which is especially true for U.S. Treasury debt and mortgage debt through the government-sponsored enterprises (GSEs).

To combat the economic fallout from COVID-19, the Federal Reserve has returned to quantitative-easing mode and is buying longer-term securities. Increasing the money supply in this way should have four effects in the following order. First, asset prices should increase, then the real economy (jobs and GDP) should grow. Inevitably, inflation happens and the Fed will then likely increase rates in order to abate inflation.

The U.S. will be stuck in the first phase until pandemic-related angst dissipates. The economy will grow, but it will happen slowly. Once businesses reopen, there will be a rise in jobs and GDP, but this will soon slow. It could take as long as 10 years to start seeing significant inflation.

Equity prices have been almost completely disconnected from inherent values and are being driven to impractical levels by momentum trading that is amplified by quantitative easing. When reality sets in, some experts believe equities are due for a significant correction. Money will move to the safety of fixed-income securities, forcing lower Treasury yields and keeping mortgage rates low.

Although some of the pandemic-fueled job losses will recover, the fact is that many businesses both large and small will be permanently closed. It may take years to regain jobs to the level of February 2020. As weak job and GDP data continue, investors likely will decide that the prices which equities were driven to by quantitative easing simply were not supported by earnings and that potential earnings were overestimated. 

The economy is akin to an overstocked store with too few customers. Stores react by lowering prices. This downward pressure on inflation will drive Treasury and mortgage rates lower.

Dual mandate

The Federal Reserve has the dual mandate of keeping the rates of inflation and unemployment low. Before COVID-19, both had been remarkably low. Inflation, as measured by the consumer price index (CPI) — the average change over time in the prices paid by urban consumers — has not been above 3% since December 2011. 

The CPI was at 2.3% in February 2020, the last month prior to the pandemic. In the same month, the unemployment rate was 3.5%, matching a 50-year low set for a few months in 2019. Fourth-quarter 2019 GDP grew annually by 2.1%. It is fortunate that the pandemic struck at a time when the U.S. economy was extremely strong. 

In late August 2020, the Fed announced that if both goals of the dual mandate could not be simultaneously achieved, it would give priority to achieving low unemployment versus keeping inflation below 2%. It did this in what was seen as an awkward manner by stating that it would use average inflation as measured by the CPI over a longer-term period rather than the most current CPI.

Although this policy change has been severely questioned by those who write about the Fed and monetary policy, it is likely a sensible choice. The U.S. needs to have the significantly large number of people who are not working return to the labor force, get paid and be able to take care of themselves. Inflation, while not a positive, is less important than getting people employed.

It also is worth noting that inflation has two sides. One is the cost of goods and services, such as food, energy and housing. These can easily fluctuate up and down. A more permanent form of inflation is wage inflation, which rarely moves down after moving up. It is unlikely at present that encouraging employment is going to cause significant wage inflation. As long as many people are applying for a job opening, employers do not have to raise wages to fill jobs. 

Reemployment will likely happen over a period of years rather than months. This will involve inflation and keep mortgage rates down. The likely absence of wage inflation as the unemployment rate declines will tame price inflation. 

The present state of the GDP, consumer prices and unemployment are caused by an event which has not happened since the 1918 flu pandemic. A weakened economy will result in very low inflation, which will keep interest rates low. The economy is akin to an overstocked store with too few customers. Stores react by lowering prices. This downward pressure on inflation will drive Treasury and mortgage rates lower.

All of these factors will play a role in keeping interest rates low at least through next year. And that’s good for mortgage originators as well as borrowers. ●

The post Safe Harbor appeared first on Scotsman Guide.

First, it’s important to understand what Collins v. Mnuchin is about. The federal government is arguing that by instituting a so-called net worth sweep — which allows it to place all of Fannie Mae’s and Freddie Mac’s profits into the U.S. Treasury — it saved the enterprises from a vicious cycle of borrowing more money and paying out more dividends. 

The government also claims it has maintained the safeness and soundness of the GSEs while rescuing them from insolvency. Increasingly, however, there is debate that Fannie and Freddie weren’t as insolvent as it appeared during the housing crisis. Instead, it’s looking like the government seized their profits to bail out the nation’s largest banks, which were arguably the main cause of the housing crisis in the late 2000s.

The plaintiffs are arguing that the government hasn’t been protecting the GSEs and that, as their conservator, it doesn’t have the right to run them in such a way that they are harmed in the process. At the core of the issue are the dividends that were paid to the GSEs’ preferred shareholders, which the plaintiffs say the government had no right to take. Although much of the direct impact of the Collins case will be felt by Fannie’s and Freddie’s investors, any final rulings also could send a ripple effect through the housing-finance industry. 

Current status

History shows us that the health of the GSEs has major implications for the housing-finance industry as a whole. Some industry pundits have argued that if Joe Biden wins the presidential election (Biden was the projected winner, but results had yet to be certified at press time), this would put an immediate halt to GSE-reform efforts.

Odeon Capital Group analyst Dick Bove, however, pointed out this past September that no matter who is in the White House, they will need a strong economy, and a key part of that is a strong housing market. It could be argued that Fannie Mae and Freddie Mac must be taken out of conservatorship to strengthen the housing-finance market, even though it has been doing quite well despite the COVID-19 pandemic. 

The demographics of the housing market are strong. The population of working-age adults (especially those under 45 years old) is climbing, which is a good sign for homeownership. U.S. money supply is growing year over year by nearly 25%, which is the highest rate since at least 1980, when the landmark Monetary Control Act was passed. Interest rates remain near record lows, while the pandemic is causing more households to move out of major cities and is increasing the demand for larger homes to meet remote-working needs. 

Private-sector growth

Bove also argues that for the housing-finance market to build on these promising trends, it needs Fannie Mae and Freddie Mac to be private entities that issue mortgage-backed securities with “quasi government guarantees” for 30-year mortgages. He points out that the government doesn’t have the ability to fund housing growth by capturing trillions of dollars but the private sector does. 

By removing the GSEs from conservatorship, the mortgage industry would be able to tap private coffers to fuel growth in housing, which in turn should drive an overall economic recovery. To be able to tap private funds, Fannie and Freddie must be released from conservatorship and arranged in a manner that gave them a strong position prior to the subprime mortgage crisis. 

The plaintiffs in the Collins case are arguing that the GSEs were not insolvent at the time they entered conservatorship. Further, Bove notes that no major housing innovations have occurred in the past 12 years, which is how long Fannie and Freddie have been in conservatorship. Without innovations, the mortgage industry can’t return to the growth it once enjoyed. 

If the Collins case results in a removal of the net worth sweep…it could pave the way for the GSEs to be released from their conservatorships.

Potential implications

Many would argue that the big banks — not the GSEs — were the real cause of the housing crisis. For this reason, it makes no sense to keep the GSEs from the position they were in before the crisis occurred. 

If the Collins case results in a removal of the net worth sweep, as many believe it will, it could pave the way for the GSEs to be released from their conservatorships. This would be a good thing for the mortgage industry, which needs the 30-year mortgage because it enables more people to own homes. 

It’s impractical for big banks to hold mortgages on their books for 30 years, and there is even less incentive when interest rates are so low, which is why they sell loans to the GSEs. When the enterprises are restored to their previous positions as private entities, the housing-finance industry will be free to grow through the support of private money rather than being held back by government limitations. ●

The post Viewpoint: Court Case Likely Will Have a Ripple Effect appeared first on Scotsman Guide.