Bank of America/Merrill Lynch says its official outlook
for the economy is neither that of a Bull forecasting a cyclical surge or a
Bear’s view of secular stagnation.
Rather, the company says it is looking for a low growth recovery.
Chris Flanagan, head of the company’s U.S. Mortgage and
Structured Finance Research has written a paper titled Mortgages: the big picture
in which he lays out a lot of theories and a lot of projections.
Looking ahead to
the end of 2015 Flanagan first sees only minimal growth in Real GDP. From its 3.1 percent level in the fourth
quarter of 2013 he sees it dipping to 2.1 percent this year and ending 2015 at 3.2
percent. From the end of 2012 to the end
of 2015 the Core PCE (personal
consumption expenditures price index excluding food and energy) will have risen
only a net 0.1 percent, from 1.6 to 1.7 percent. The Federal Funds rate may as much as
quadruple in the next year but still will not cross above 1 percent and he
projects that the 10 Year Treasury Note rate, currently at 3.10 percent we rise
to 3.75 percent. The only real
indication of an improving economy will be unemployment which, from 8.1 percent
at the end of 2012 he forecasts at 5.5 percent by the end of next year, falling
even further after that.
What happens to the economy of course is
critical to what will happen to interest rates and thus to the mortgage
industry. Flanagan points to some
current indicators and what they might mean for the industry looking ahead.
A declining unemployment rate, is usually
accompanied by a flatting yield curve and he sees the spread between 2 year and
10 year at zero by the time unemployment hits 4 percent at the end of 2016. Both credit and volatility tend to be, as
Flanagan puts it, “well behaved in flatteners.”
The demand for non-mortgage types of credit,
commercial, corporate, and consumer, has returned more closely to normal in the
wake of the recession. But both the
supply of and demand for mortgage credit remain very weak and for several
Homeownership peaked in the fourth quarter of
2004 at 69.2 percent then began a gradual decline that brought it down to its
current 64.7 percent. Even after that
decline began credit continued to expand and did not peak until the second
quarter of 2006. At that point the
Mortgage Bankers Association says its recently introduced Mortgage Credit
Availability Index would have been at 868.71 percent. It has been coasting along in the
neighborhood of 100 since late 2007 or early 2008.
Flanagan blames this tight credit on the last
five years of regulation, litigation, and government intervention.
The lack of a normal mortgage market, especially
tight credit, is having a major impact on most aspects of residential real
estate – some negative and some positive.
While new home sales have suffered, prices have risen, yet affordability
has remained high.
Flanagan sees the lack of supply and demand as
indicating a need for further monetary accommodation as Quantitative Easing (QE)
winds down although a zero interest policy is expected to continue through the
second quarter of next year.
Like loose lips sinking ships Flanagan shows
that even talk about the Federal Reserves’ intention to taper QE had an impact
on interest rates, mortgage origination and employment in the industry.
Homeownership grew quickly in the 1990s, the
most precipitous increase can be dated to a call from President Clinton for a
national homeownership effort in 1994, and as might be expected the volume of
purchase mortgage applications increased right along with it. The 2004 peak in the former closely
approximated the peak in the latter and both have proceeded down in near
The relationship isn’t quite as close between
the decline in homeownership and the growth and retraction in GSE portfolios. Portfolio
growth tracked closely from the mid 1980 through the peak and during the first
few years of homeownership decline. But
the portfolios did not begin to decline in earnest until the GSEs were mandated
to liquidate them as a condition of their federal conservatorship. With those portfolios down to slightly more
than half their size in 2008 Flanagan says this could be an opportunity for
real estate investment trusts (REITs) to fill the void.
Declining homeownership equals declining home
purchase mortgages and that, together with the declining GSE portfolios, means
a much smaller investment in MBS, especially Agency MBS. The paper points out that of the 5.47
trillion in U.S. fixed income gross issuance in 2008, 20.8 percent was Agency
MBS and 16.7 percent was Treasury notes. With a substantially smaller issue
($4.38 trillion) in 2014 the Agency MBS share has dropped to 13.1 percent while
Treasury has 31.6 percent.
Flanagan says the stable and low MBS spreads
along with low volatility seem to be the new normal in the mortgage world and
again he points to the current environment as providing opportunity for REITS
as the Federal Reserve and the GSEs no longer continue to grow their