Mortgage Rates Are Not Buying The Rally Yet By Brent Nyitray, CFA, MBA - Disclosure Dec 1, 2014 10:01 am EST Mortgage rates are the lifeblood of the housing market. This is why the Fed began quantitative easing in the first place. Lower rates allow homeowners to refinance. Refinancing increases homeowners’ disposable income. It also helps stimulate economic growth.
Lower rates allow first-time homebuyers to move out of apartments and into houses. This means higher consumption and benefits for home improvement retailers such as Home Depot and Lowe’s. Consumption accounts for ~70% of the US economy. Mortgage rates not believing the bond rally yet Over the past several months, mortgage rates and the ten-year bond yield stopped correlating. Last week, this trend broke as the two variables lined up once again. We’ll have to wait to see if this trend continues.
The average 30-year fixed-rate mortgage decreased six basis points to close at 3.92%. The ten-year bond rose and yields decreased by 15 basis points. Mortgage rates seem to be waiting for confirmation that Friday’s rally was “real” before adjusting.
Many originators are now beginning to originate stated-income loans—not to be confused with liar loans of the sub-prime days. These loans will have a higher interest rate than a generic Fannie Mae 30-year loan. That could explain why mortgage rates increased. If this is the case, it could be the impact that builders were waiting for. Tight credit has been a problem for builders for a long time.
FHFA Chairman Mel Watt announced measures intended to increase access to credit at the annual Mortgage Bankers Association conference in Las Vegas. One of these measures is supposedly a 3%-down Fannie Mae loan. This would be a very welcome development for the builders.
Effect on homebuilders
Homebuilders, such as Lennar Corporation (LEN), Toll Brothers (TOL), and PulteGroup (PHM), reported decent earnings. We heard from D.R. Horton (DHI) recently. Texas, Florida, and the Carolinas are strong, but the Midwest is still lagging.
An alternate way to invest in the sector is through the SPDR S&P Homebuilders ETF (XHB). Since the economy’s household formation numbers are depressed, there’s real built-up demand for housing. DHI $25.24 -$0.25 -0.98% LEN $46.70 -$0.54 -1.14% PHM $21.67 $0.04 0.19% TOL $34.59 -$0.41 -1.16% XHB $33.15 -$0.32 -0.96% There are no shortcuts to investing.
But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.
I Agree Part 5 Critical Releases For REIT and Homebuilder Investors (Part 5 of 6)
Fannie Mae Securities Follow Bonds Higher
By Brent Nyitray, CFA, MBA - Disclosure • Dec 1, 2014 10:01 am EST Fannie Mae and the to-be-announced market
When the Federal Reserve talks about buying mortgage-backed securities (or MBS), it’s referring to the to-be-announced (or TBA) market. The TBA market allows loan originators to take individual loans and turn them into a homogeneous product that you can trade. TBAs settle once a month.
Fannie Mae loans go into Fannie Mae securities. TBAs are broken out by coupon rate and settlement date. In this chart, we see the Fannie Mae 3.5% coupon for the December delivery.
Fannie Mae TBAEnlarge Graph
TBA market rallies despite a flattish bond market
The Fannie Mae 3.5% TBA started the week at 103 22/32 and picked up 15 ticks to close at 104 7/32.
Market participants may also be forecasting less volatility in interest rates. This benefits mortgage-backed securities. Also, the Financial Industry Regulatory Authority (or FINRA) is announcing new margin requirements for TBA securities. These requirements will deeply affect smaller mortgage lenders.
Implications for mortgage REITs
Mortgage REITs and exchange-traded funds (or ETFs), such as Annaly Capital Management (NLY), American Capital Agency (AGNC), Capstead Mortgage (CMO), the iShares 20+ Year Treasury Bond ETF (TLT), and the Market Vectors ETF Trust (MORT), are the biggest beneficiaries of quantitative easing. Quantitative easing helps keep REITs’ cost of funds low. REITs benefit from mark-to-market gains. This means existing holdings of mortgage-backed securities are worth more as the TBA market rises.
The downside is that interest margins compress going forward because yield moves inversely with price. Also, as MBS rally, prepayments are likely to increase. This negatively affects mortgage REITs.
As a general rule, a lack of volatility is good for mortgage REITs, which hedge some interest rate risk. Increasing volatility in interest rates increases the cost of hedging. This is because as interest rates increase, the expected maturity of the bond increases because there will be fewer prepayments. On the other hand, if interest rates decrease, the maturity shortens due to higher prepayment risks.
AGNC $23.02 -$0.06 -0.24% CMO $13.00 -$0.01 -0.08% MORT $25.18 $0.12 0.48% NLY $11.51 -$0.01 -0.09% TLT $122.34 -$0.15 -0.12% Part 6 Critical Releases For REIT and Homebuilder Investors (Part 6 of 6)
Ginnie Mae Securities Pick Up Steam As Bonds Rally
By Brent Nyitray, CFA, MBA - Disclosure • Dec 1, 2014 10:01 am EST Ginnie Mae and the to-be-announced market
The Fannie Mae to-be-announced (or TBA) market represents the usual conforming loan—the plain Fannie Mae 30-year mortgage. Meanwhile, Ginnie Mae TBAs are where government loans go—such as the federal housing administration (or FHA) and veterans affairs (or VA) loans.
The biggest difference between a Fannie Mae mortgage-backed security (or MBS) and a Ginnie Mae MBS is that Ginnies have an explicit guarantee from the federal government. Fannies don’t have a guarantee—just a wink-wink, nudge-nudge guarantee. As a result, Ginnie Mae MBS trade at a premium compared to Fannie Mae TBAs.
There are two different Ginnie Mae TBAs—Ginnie 1s and Ginnie 2s. Ginnie 1 TBAs include mortgages with the exact same coupon payment. Ginnie 2 TBAs can include a variety of coupons within a range.
Since you can have more certainty with Ginnie 1s compared to the 2s, the 1s typically trade at a premium. This premium can vary. You’ll often see investors switch between 1s and 2s as a relative value trade. The Ginnie Mae 1s tend to be more liquid than the 2s and have narrower bid-to-ask spreads.
Ginnie Mae mortgage-backed securities rally
The ten-year bond had a big rally, with yields decreasing from 2.31% to 2.16%. Ginnie Mae TBAs rallied as well, rising from 104 17/32 to 104 31/32.
Implications for mortgage REITs
Mortgage REITs, such as Annaly Capital Management (NLY), American Capital Agency (AGNC), MFA Financial (MFA), and Capstead Mortgage Corporation (CMO), announced big drops in book value per share. Rising rates hurt the value of their mortgage-backed security holdings. The REIT sector spent most of 2013 deleveraging to position itself for rate increases.
As a general rule, a lack of volatility is good for mortgage REITs and the mortgage REIT ETF (MORT), which hedge some interest rate risk. Increasing volatility in interest rates increases the cost of hedging. As interest rates rise, the expected maturity of the bond increases because there will be fewer pre-payments. On the other hand, if interest rates fall, the maturity shortens due to higher prepayment risk.
Mechanically, this means mortgage REITs have to adjust hedges and buy more protection when prices are high. Then, they have to sell more protection when prices are low. This buy-high, sell-low effect is called “negative convexity.” It explains why Ginnie Mae MBS yield so much more than Treasuries. Both have no credit risk.
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