Experts 2012 Rate Outlook; 2011 Forecasts that Failed; MBS Capital Ratio Chatter; Basel III Thoughts

We wrap up
the year with the SP (a better broad measure of stock performance than the
DOW) essentially flat on the year, but 10-yr yields nearly 1.5% lower than a
year ago. For 2012 fixed-income traders seem focused on the U.S. election and
continued bickering, more regulation in the U.S., Europe and its eventual
endgame, where U.S. data shows the economy is headed, will the Middle East ever
be stable, and what will happen to China. They are pretty much the same things
as a year ago.

So where is the economy, and rates,
Freddie Mac revealed its outlook,
forecasting that U.S. economic growth would likely climb to 2.5 percent over
2012 and that mortgage rates would stay at record lows. “While the headwinds
remain strong going into 2012, there are indications the economy and the
housing market are gaining ground, albeit slowly,” Frank Nothaft, VP and chief
economist with Freddie, said in a statement. The company said that mortgage
rates would stay low, with 4 percent for the 30-year fixed-rate mortgage
leading the way recently. Nothaft forecasted that recent modifications to the
Home Affordable Refinance Program would increase refinance originations by more
than $100 billion over the next year, giving a lift to purchase-money biz but
letting single-family originations enter a shortfall over the next year.

Another forecast noted, “We expect 2012 to be a fairly similar year to
2011 for the mortgage market. While we expect a decline in residential mortgage
volume (forecast a moderate decline in mortgage origination volume in 2012 to
$1.1 trillion from an estimated $1.2 trillion in 2011) as refinance activity
tapers off, originations should get
support from still low rates and implementation of HARP 2.0. The lower volumes
will likely lead to weaker mortgage production margins
. Mortgage credit is
likely to remain stable although we expect increasing delinquency rates on FHA
loans. We expect little mortgage market reform through Congress, but there
could be some changes driven by the regulators such as the release of a
definition of a Qualified Residential Mortgage (QRM) and the introduction of a
GSE risk-sharing pilot program.” So noted a research piece from Keefe, Bruyette Woods, Inc.

Fannie Mae’s chief economist,
however, is warning that the United States has a 40% chance of slipping into a
double-dip recession in 2012. Recently Doug Duncan predicted a 50% chance of a
double-dip recession next year, due to persistently high unemployment and the
ongoing housing slump. But an uptick in job growth and stronger automotive and
retail sales forced Duncan to revise his dour forecast slightly upward. He does
not anticipate the housing market to fully rebound before 2015. And he expects
to see plenty of contagion from Europe. One of the major problems is the
housing market, he says. In past downturns, home sales have led a recovery, but
this time around low interest rates have not pulled mortgage lending or
consumer sentiment out of the doldrums. Chronically high unemployment over the
next decade and weak income growth will continue to expert pressure on housing
prices, he says: “Until employment picks up, you won’t see any improvement
in housing.” Check it out.

Rarely do forecasts come true 100% of
the time, however, and there were some from last year that did not
. There was no double-dip recession in
2011, and the year is ending on a positive note with the U.S. economy is
growing at an estimated 3.5-4% annualized pace in the fourth quarter. The
European currency union did not come apart in 2011, although it had a few
near-death experiences requiring multiple summits. The 11 countries that hitched
their wagon to the common currency in 1999 and the 6 that joined subsequently are
still together. About a year ago banking analyst Meredith Whitney’s forecast of
a large number of municipal defaults failed to materialize, fortunately, with
less than $2 billion going into default according to a report from Bank of
America Merrill Lynch. In fact, the U.S. Census Bureau just reported that state
and local
government tax collections rose 4.1 percent in the third quarter from a year
earlier, the eighth consecutive increase.

disaster is always on the minds of many, and the Federal Reserve issued
proposals intended to prevent the collapse of major financial firms. “The
proposal would create an integrated set of requirements that seeks to
meaningfully reduce the probability of failure of systemically important
companies and minimize damage to the financial system and the broader economy
in the event such a company fails,” a Fed statement said.

Federal Reserve released a draft proposal that outlines a change to the
liquidity capital ratio (LCR) tests that are included in the Basel III reforms.
It is important to note that the treatment of conventional and Ginnie Mae MBS
was only one small part of the Fed’s proposal, titled “Enhanced Prudential
Standards and Early Remediation Requirements for Covered Companies.” Under the Fed’s proposal, Fannie and
Freddie securities would be classified as “highly liquid assets,” the same
liquidity treatment as Ginnie Maes
. This makes agency MBS more appealing
for purposes of attaining liquidity benchmarks. Remember that liquidity capital is not risk-based capital
– the 20% risk-based capital weighting for Fannie and Freddie MBS is not going
away, which means that the more restrictive capital requirements will remain
untouched. For the purposes of risk-weighting, Ginnies are still classified as
“Level 1” assets, while conventional MBS are labeled as “Level 2.” The risk weighting assigned to
any asset is determined by the Basel Committee for Banking Supervision – not
the Federal Reserve. And overseas investors buy Ginnie MBS’s for reasons that
have little to do with the Basel III capital requirements. For these investors,
the liquidity test is far less relevant than the presence of a full US government guarantee – something that is not going to change any time
soon. All this is open to comments for the next three months.

wrote, “The Basel III regulations show that ultimately I don’t think that the
United States banks can say to the world that they don’t have to follow the
same rules as everyone else. They can’t say, ‘Hey world, don’t worry about us
and residential lending- we know what we are doing.’ The main contention for
the Clearing House around Basel III is that it caps tier 1 capital reserves for
MSR at about 10% (if my research is correct). This means that a bank like Wells
Fargo that has $125 billion in Tier 1 capital would be limited to $12.5 billion
in MSR (mortgage servicing rights). Depending on where the MSR is marked (say 4x
servicing values, for example, on a Fannie Mae MSR although I think the norm is
about 86-100 bps right now), and assuming that the strip is .25%, then the
total amount of servicing that Wells Fargo could hold would be somewhere in the
neighborhood of $1.25 trillion. This has huge implications. Think about the
fire sale of servicing or reduction in production by the larger banks that has
to occur between now and 2018 (when Basel III is slated to go into effect). We
are already seeing servicing values reflect this uncertainty.”

continues, “Does it matter that the large aggregators are going to be reducing
their holdings of MSR due to Basel III? Why is this good or bad? It will allow
free flow of capital from foreign markets because we are all on the same ‘regulatory
path’- something we will need for our recovery. This is also the intention
behind Dodd Frank of course. It will allow the aging western civilization to
match cash flows that suit their lifestyle with something other than treasuries
and still have some relative notion of safety – even as credit widens because
the concentrated risk in one institution would be much smaller. More players,
in the mortgage lending part of banking, mean more competition. This drives
cost to the consumer down and it also reduces systemic risk. The servicing
value attributed to MSRs is in direct correlation to what a small aggregator
can reasonably put on its books. Basically, if someone is out “buying the
market” with higher servicing multiples, due to business a differing business
strategy or overhead, then this would keep smaller servicers from being able to
acquire the best quality loans at a reasonable price.

“But if
banks need to make higher yields they are invariably going to chase higher risk
assets to do so. The markets ‘are what they are’ and they will need to do this –
they can’t just inflate margins on commodities- it will only work in the short
run. Too much regulation could lengthen the recession. It could stifle growth
of our largest banks and this is not good for a large economy like ours- we
need supersized banks to handle massive sized projects that we have in the
United States- it’s what makes our economy so incredible. Money center banks
are important and we need them to stay relatively large.” So wrote Matt Ostrander,
CEO, Parkside Lending, at

Turning to
the markets, the National Association of Realtors (NAR) announced yesterday
that pending home sales in November
reached the highest levels seen in 19 months
. Many view this number as
a leading indicator of the level of sales over the next 30 to 90 days, and is
based on signed contracts for home purchases and does not reflect transaction
closings. Lawrence Yun, NAR chief economist, said the gains may result partially
from delayed transactions – pent-up demand. But any LO will tell you that contract
failures have been running unusually high, often due to mortgage approval or
appraisal problems.

No one is
complaining about mortgage rates, and volatility is pretty low heading into
year-end. Yesterday the “benchmark” 10-yr T-note closed at 1.90%, but on the
mortgage side MBS prices improved slightly on little supply and continued
decent demand. (Remember overnight rates are set by the Fed, mortgage rates are
set more by supply and demand.) There was a little news yesterday, but none
today – even Europe has quieted down somewhat. The 10-yr is currently trading around 1.90% and agency MBS prices
roughly unchanged in the early going prior to the early bond market close and
Monday’s holiday.

Dear God –

My prayer for 2012 is for a fat bank account a thin body.

don’t mix these up like you did last year.

If you’re interested, visit my twice-a-month blog at the STRATMOR Group web
site located at The current blog discusses the time
frames for borrowers returning to A-paper status after a short sale or
foreclosure. If you have both the time and inclination, make a comment on
what I have written, or on other comments so that folks can learn what’s going
on out there from the other readers.

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