Are We in for a Housing Market Correction?
The start of 2022 has seen market corrections in risk assets, which has led to murmurs of a potential correction in home prices as the Federal Reserve’s tapering of asset purchases leads to higher mortgage rates. Housing prices have risen dramatically (nearly 20% nationwide, per Case Shiller and FHFA) over the past year, and even if many people feel that meteoric rise makes conditions ripe for a bubble, a closer look reveals that is not necessarily the case.
Simply put, housing demand is drastically outpacing supply, and higher mortgage rates should do little to change that dynamic. There are 72 million millennials running around wanting to buy homes, and, on average, 5 million people turn 30 each year, well above the recent 1.6 million-unit annual pace of housing starts and building permits. Builders aren’t building enough to keep up with demand, and very few people are selling. Aging baby boomers aren’t selling their houses, and large companies that bought tens of thousands of homes from 2008 to 2012 are content to keep renting those out rather than putting them on the market. Per NAR, December inventory of homes for sale was down to 1.9 months’ supply, a record-low and 14% below a year ago. The average amount of time that someone lives in a home has risen to nearly 11 years. Existing Home Sales fell in December, however, 2021 was the best year since 2006.
Low mortgage rates have helped create the current balance of supply and demand. Millions of homeowners refinanced into historically-low mortgage rates since the onset of the pandemic, which has helped keep existing home supply low. Those low mortgage rates have also increased home purchasing power and spurred those on the fence about buying a home to hop in on the action, or at least try to. Even with the recent rise in mortgage rates, they are still low by historical standards and demand has yet to wane. Rising incomes are expected to offset the increase in mortgage rates, meaning DTIs aren’t going to change all that much, and professional investors will still find mortgage assets attractive relative to other investment opportunities.
So, where are the murmurs of a housing bubble or crash coming from? The Fed has accelerated the pace at which it reduces monetary accommodation, and is expected to continue to tighten over the next couple years as it fights inflation. The resulting rise in interest rates will likely put additional stress on housing affordability. Some believe demand has no direction to go except to cool unless people start tapping their home equity to upgrade, a Covid migration 2.0 happens, or Millennials actually make good on their prime home-buying years.
Additionally, the rate of savings has also declined over the course of the pandemic and ‘excess’ saving will likely be eroded and affordability increasingly constrained. Fannie Mae has observed recent increases in debt-to-income values on incoming mortgage originations. There are also headwinds from Covid, labor shortages, and inflationary pressures that may moderate economic growth.
As the impacts of fiscal stimulus fade, Fannie Mae anticipates that 2022 will establish a new “normal” for the housing market, with inflation remaining elevated and home price appreciation slowing to the high single digits. Fannie expects GDP to fall to 3.1% for the year (still above pre-pandemic levels), home price appreciation to grow 7.6%, and inflation to start the year at 7% before slowing to 4% by December. Leading Economic Indicators, according to the Conference Board, are strong and ended 2021 on an upward trajectory, suggesting the economy will continue to expand well into the spring.
Fortunately, conditions are also much healthier from a lending perspective than 15 years ago. The mortgage industry is in a much better position than it was before causing the last housing crisis. Regulations (e.g., Dodd Frank) and oversight (e.g., the CFPB) have been installed to prevent mortgage assets from containing the explicit and underlying risk seen in the lead up to 2008. The current non-QM space is also originating to a higher credit box than the subprime and alt-a loans of the early aughts.
Rising prices alone are not a sign of a bubble. While the general lack of concern surrounding higher prices and increases in credit availability echoes similarities from that of 2008, demand in the purchase market should remain strong, even if rising rates and limited supply crimp the number of originations this year. The shortage in housing supply certainly isn’t going away in 2022, meaning that a decline in home sales is not going to come from a lack of demand. While few economists believe that the current run-up in housing prices is a bubble that’s about to burst, practically no one was worried about the housing bubble in 2007, meaning mitigating risk in your business is always a prudent practice.
Mitigating Risk in 2022 and Increasing Profitability
There is nothing we love more than seeing our clients maximize profitability, regardless of market conditions. The advantage of having a sound lock policy, explicit hedging strategy, and robust MSR valuation is always evident, but it is paramount in times of volatility. And volatility has certainly gripped financial markets to open the year. The Fannie 2.5 is down about 2 points since the start of the year and the U.S. 10-year Treasury yield has gone up around 30 basis points. There are several ways we recommend mitigating risk to ensure profitability.
Shift from best efforts to mandatory loan sales. Selling loans on a best efforts basis exposes those doing so to the risk of market movement. The economic incentive for switching to mandatory delivery begins to make more sense when lenders reach roughly $10 million per month in loan volume. “Some lenders can expect a 20 basis point pick-up on conventional volume, and a 40 basis point pick-up on government volume,” according to our COO, Phil Rasori.
Another way to mitigate risk is by optimizing your investor set. It’s an often-overlooked way to easily pick up 12+ basis points, allowing your company to get the best price for a specific product you are selling, and in the most efficient manner. Most know what it means to get the best price, but don’t necessarily know how to go about it or how to achieve it effectively and efficiently. One of the main features of MCT’s Bid Auction Manager (BAM) whole loan trading platform is the ability to evaluate potential new investors before proceeding with the investor’s approval process, providing both time and money savings. And BAM Marketplace allows lenders to find competitive outlets even during periods of decreasing liquidity.
Don’t bank on rate-and-term refinances. According to the Mortgage Bankers Association, refinances are set to decrease by $1 trillion in 2022. Although the refinance business was booming the last two years, this year it is expected to slow as mortgage rates begin to rise more swiftly. Purchase loans are going to take the spotlight and adjusting accordingly will be key. However, it’s not all doom and gloom: there is still solid demand for cash-out refinances and even with rising rates, the overall refinance population (sitting at roughly 11 million) still could save an aggregate of nearly $1.6 billion each month, or about $275/month per borrower. There are still over a million candidates remaining who could save at least $400/month.
Rising rates mean rising MSR values, which can help to provide stability in revenue from servicing. Portfolios have grown a lot over the last couple years, meaning servicing is now the primary revenue source for many originators. A sound MSR strategy can significantly lift your profitability,
Some other things we recommend include staying on top of your coverage, mapping your coupons correctly, trading frequently, having a strong set of decision making analytics and processes, putting together a budget, hiring a Chief Risk Officer, tightening up lock policies (tracking and managing rate exceptions more closely, no free extensions, and handling end-of-day locks, overnight locks, and weekend locks) and using AOTs to take the cash you’re making on trades and bringing it forward into loans.
There are always actions companies can take to mitigate risk. In both times of market calm and times of market volatility, MCT has software, and services for every step of the secondary marketing cycle. Give our 15 Strategies for Lenders to Improve Profitability Whitepaper a read and reach out to MCT for help in any or all of the above recommended areas.