Residential: Mortgage industry still has bright spots amid mixed economic and housing outlook

“I think there is a high and growing risk of a recession in 2020. You know, put it at odds of something like 1 in 3.”

Mike Fratantoni, Chief Economist and Senior Vice President of Research and Industry Technology for the Mortgage Bankers Association (MBA), delivered those words last week in a webinar hosted by MountainView Financial Solutions, a Situs company. Fratantoni shared an outlook in a broad to narrow scope that covered economic conditions, the housing market and the residential mortgage industry, and in each of those three areas he provided a mix of good and bad news.

“The expectation is that the global economy is going to slow, and that’s true regardless of what part of the globe you’re looking at,” said Fratantoni. He predicted a slowdown in China, parts of Europe and the US.

In the US, Fratantoni said the MBA is forecasting a drop in annual GDP growth from 3.1% in 2018 to 2.1% in 2019 and 1.4% in 2020 and 2021. While those declines are significant, he said it’s important to keep the levels in context.

“We think that over the next decade, GDP growth in the US is going to average about 1.7%,” said Fratantoni . “So 2.1% is still pretty good, historically speaking, and that’s going to be enough to lead to continued improvements in the job market.”

He then showed the MBA’s forecast of the US unemployment rate averaging 3.5% in 2019, 3.6% in 2020 and 3.7% in 2021.

Fratantoni also said the MBA sees the inflation rate hovering around the Federal Reserve’s 2.0% target for the next three years, but that the full set of economic data is telling the Fed to tighten interest rates more. With this in mind, he stated that the MBA is predicting two additional interest rate hikes this year.

Fratantoni said the MBA is expecting short-term rates to go up 50 basis points and thinks the next hikes will be in the middle of this year and in December. He also said the Federal Funds Rate target will end up somewhere just short of 3% for this rate cycle and that longer-term rates are close to leveling out.

Fratantoni then showed a chart with the historical spread between 2-year and 3-month Treasury yields, a spread that the Fed really keys on as a very reliable recession indicator, he said.

“The fact that this is flattening is clearly a sign that investors are looking for slower growth ahead,” said Fratantoni.

In perhaps seeking to lessen worries for the webinar audience, he shared charts showing that the current level of household debt has declined significantly since the financial crisis. Fratantoni said most consumers currently have the financial strength to weather a recession by taking on additional debt.

Regarding rates for 30-year mortgages, he said the MBA expects rates to be in the range of 4.5% to 5% for the next couple of years, and he indicated that this range would be among other favorable factors for the industry.

“In some ways, even though maybe we’re a touch higher than where we were in 2018, I think a steadier rate environment is going to be positive for the market, coupled with home price growth that would be sustainable – at a slower pace than what we’ve seen before,” Fratantoni said. “I also think housing demand is going to be there and we’re going to see some additional supply come on line.”

He showed forecasted mortgage originations for 2019 and 2020 staying around the same level as 2018 and slightly increasing for 2021, with approximately 75% being purchases and 25% being refinances. Tied to this, Fratantoni showed a forecast of low-single-digit growth in purchase originations over the next three years and said the majority of any increases in refinancing originations will be cash-out refis.

The low inventory of homes for sales, coupled with high home prices, however, is still a headwind for the housing market, according to Fratantoni. He showed that prices year-over-year aren’t rising as much as in recent years, but the increases are still hard for most homebuyers to absorb.

“Think about a 6% annual growth in home prices in a country where we’re happy that wage growth is up to 3.2%,” said Fratantoni. “So you still have home prices at almost twice the rate of income growth, and that just can’t be sustained very long. And what we really saw beginning in Q2 and Q3 of last year is that affordability became such a challenge that homes were staying on the market longer and sellers were having to be a little less aggressive in terms of listing prices, and you see that in terms of realized prices as well.“

The flip side of increasing home prices is that people who have owned homes over the last 5-8 years have seen tremendous growth of their equity, according to Fratantoni. He said this equity, combined with a steadier rate environment and a little more inventory on the market, could lead to more move-up buyers – people who cash out the equity in their entry-level homes and finally go to a larger space, making a move they’ve been delaying for a number of years.

Fratantoni next discussed how lenders and servicers are faring in this challenging environment, and he stated upfront that this third part of his presentation is where he really delivers the bad news. He showed a chart displaying declines in independent mortgage bank (IMB) average production volumes over recent years, simultaneously coupled with decreases in net production income. The chart illustrated how these originators are hurting in two ways, and Fratantoni predicted similarly rough numbers for Q4 2018 and Q1 2019.

While IMBs have been continuously grabbing servicing volume share from depository institutions over the last eight years, Fratantoni shared a chart showing how IMBs have also been retaining less servicing for each of the past five quarters. In explaining the downward trend in the chart, he said IMBs are choosing to sell more loans with servicing released for additional cash up front and more liquidity, given the challenges in the current environment. With the trend of IMBs retaining less servicing, he said it will be interesting to see whether this IMB servicing volume share trend flattens out or even reverses at some point.

On a positive note, Fratantoni said a benefit of holding servicing in the current environment is that mortgage delinquencies are at 20-year lows and foreclosure levels are at 30-year lows. He also talked about another bright spot in the residential mortgage industry right now: servicing profitability has been improving, when you look at net servicing financial income and net servicing operational income.

“From an operational context, with larger loan sizes and lower delinquency rates, servicing is a good business to be in.”

Fratantoni’s presentation was delivered in the first half of MountainView’s MSR Asset Monthly Snapshot webinar for January. In the second half of the webinar, MountainView’s panelists provided a review of interest rate changes, mortgage servicing right (MSR) risk management, MSR pricing levels and MSR market activity in December.

A recording of the full webinar is posted for industry participants to view on demand.

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