Mortgage debt keeps growing

The Fed’s first quarter Flow of Funds release, published last week, showed that mortgage debt keeps rising, even as home prices decline and financing is getting harder to find. Mortgage debt increased at a 5.4% annual rate in the first quarter, nearly three times as fast as house appreciation for the same period. Equity is declining, and at the end of Q1 2007, the ratio of equity to home value was at the record low of 52.7%. In today’s market, you don’t have to take a “cash-out” refinance to reduce the equity in your house. As prices drop, you essentially owe a larger percentage of your home’s value – without increasing your loan amount. In 2000, the equity-to-home-value ratio was 57.9, and has been steadily declining ever since. Economists predict that this ratio may drop below 50 for the first time ever in the coming months.

The drop in home equity is a logical consequence of loose lending standards during the boom years, when anyone could “buy” a house with little to no money down and hope that it would appreciate as home prices kept rising. Now that prices are flat or dropping nearly everywhere, and borrowers face monthly payments adjusting upwards, they’re being left with less and less equity in their homes. Excessive greed made owners refinance repeatedly during the boom years, draining cash out of their houses. Today, consumer confidence and spending are falling, raising concerns that the “housing slump” will affect the broader economy quite badly. Keep your fingers crossed.

Mortgage rates highest in 10 months

Mortgage rates rose again the week ending June 7^th, says a report by Freddie Mac. The 30-year fixed-rate mortgage is at 6.53, the highest reading for this year, and the highest since August 2006. Rising rates reflect strong job growth, but they certainly won’t be luring new buyers to the Real Estate market. Which, in turn, means that sellers will have to cut prices further and “the housing slump” will last for quite some time. Until the end of 2007 at the least, according to most forecasts.

The situation is exacerbated by record-high inventories of unsold homes, so it’s clearly going to take a while for the market to get back to normal. In fact, it seems that no one has a reliable estimation of the unsold homes on the market, but all analysts point out that there are too many homes for too few buyers. The Fed, however, is concerned about inflation, so rate cuts are unlikely. The Mortgage Bankers Association (MBA) believes mortgage rates will reach 7% by the end of the year. No wonder mortgage applications are dropping.

This is how the rest of the mortgage loans performed this week: 15-year fixed-rate mortgages averaged 6.22%, the 5-year adjustable-rate mortgage was at 6.24 and one-year ARMs carried an interest rate of 5.65. All interest rates were up 0.05% to 0.10%.

Mortgage loan applications slip

Mortgage loan applications declined 1.7% last week. The Mortgage Bankers Association reported a 6.1% drop in the Refinance Index from the previous week, and a 1.5% increase in the Purchase Index. This is somewhat surprising, as analysts believe that more and more homeowners who took out adjustable-rate mortgages in recent years should be refinancing.

Meanwhile, the National Association of Realtors (NAR) released an interesting statement. “Home sales are projected to move in a relatively narrow range with a gradual upturn” toward the end of the year, nothing new here. According to senior economist Lawrence Yun, “Overall housing levels are historically strong”, whatever that is supposed to mean, “but sales remain sluggish”. To me, this sounds like trying to make bad news seem good. Nothing new… He goes on to say that, because fewer high-cost homes are being purchased, the median existing-home price is being distorted, meaning that home prices are actually moving upwards, contrary to statistical data. He cites Freddie Mac’s price index as a more reliable source of information, showing that prices are actually rising, not dropping. Indeed, prices have increased somewhat in the first quarter of 2007 compared to the final 3 months of 2006, but the growth rate is only a fraction of what it was a year ago. “House price appreciation did not keep pace with the overall level of inflation during the quarter”, says Freddie Mac’s Frank Nothaft. He also added that national home price growth will probably slow down even more and price declines are expected “in many parts of the U.S.”.

Yun believes that “buyers today need to have a traditional view that housing as a long-term investment is an added benefit”. Nothing new here either, but it seems most buyers are still waiting on the sidelines for better prices and interest rates. Will a public statement from a trade group official make them change their minds?

NAR’s “U.S. Economic Outlook” forecasts price declines for both existing and new homes for the rest of the year, and predicts a 6.6% 30-year mortgage rate for Q3 and Q4. All this sounds a little saner than Lawrence Yun’s allegations, but who knows, the forecast might be amended anytime.

Bernanke: lending standards will “restrain” housing

Ben S. Bernanke, Federal Reserve Chairman, said that tightening lending standards will impact the demand for housing for longer than expected. Let’s say the initial forecasts most authorities issued were a little too optimistic to begin with. Bernanke believes “additional measures” will be required to combat fraud and abusive lending, but the Fed should be careful “not to suppress responsible lending or eliminate financing opportunities for subprime borrowers”. Fine, now we’d like to see them actually do it. Some economists have warned against additional regulation, because the market will “correct itself” anyway. Indeed the Fed is often being blamed for causing the current situation by keeping rates low for too long, so could they exacerbate the situation by intervening now?

Although Bernanke believes trouble in the housing sector has not spilled over to the larger economy, he forecasts “moderate” growth for the coming months. Job growth, manufacturing and personal spending are doing well, but some economists fear this may not last for much longer.

Rising delinquencies and foreclosures on subprime mortgages contribute to rising inventories of unsold houses, which results in declines in home prices and new construction. According to Bernanke, “the slowdown in residential construction” will likely “remain a drag on economic growth”, but it is “difficult to quantify” the impact. Knowing that housing accounts for nearly a quarter of annual economic growth, I believe no one would like to have to “quantify” the worst-case scenario.

The word “recession” is being pronounced more and more often, and with the housing slump extending for longer than expected, it seems only a question of time before the consequences of problems in the Real Estate industry are felt in the larger economy. A recession seems unlikely, but so does significant economic growth in 2007. Perhaps the Fed will deal with the problem?

Accredited acquired by private equity fund

Accredited Home Lenders Holding Co. will be sold to Lone Star Fund V PL for $400 million. The fund will buy all of Accredited’s shares for $15.10 a piece, 10% higher than the stock’s price on Friday, June 1^st. On Monday, Accredited’s stock traded for $15.12.

The offer will probably close in the third quarter of this year, which will mark the end of companies specializing solely in subprime lending as a field of business. Accredited is one of the last lenders operating exclusively in the subprime sector. NovaStar
Financial is looking for a buyer, too, and Delta Financial will probably remain in business because it did not originate adjustable-rate subprime loans.

Accredited has been “exploring strategic options” for a while now, as troubles in the subprime sector undermined its financial standing. It reduced its workforce of 4,200 by 1,300 in the first quarter, as delinquencies on its loans spiked. It had to sell most of its inventory at a substantial discount in order to raise cash, and received a $230 million term loan from Farallon Capital Management LLC. It also managed to renew an existing $600 million credit line, thus somewhat improving its situation. It was threatened by delisting from the Nasdaq Stock Exchange because it failed to file its annual report for 2006 on time, due to the resignation of its auditor, Grant Thornton LLP.

Pending Home Sales Index drops

The National Association of Realtors (NAR) announced that its Pending Home Sales Index dropped 3.2% in April from a month earlier. The index measures home purchases in which the contract has been signed but the transaction is not yet closed. It is considered a forward-looking indicator of market activity. In both March and April, the pending home index was approximately 10% lower than last year’s readings.

This drop is somewhat unexpected, because forecasts predicted a 0.4% increase. Lawrence Yun, a senior economist with the NAR, said sales of existing homes “might ease but should be fairly stable in the months ahead”. Hm… The index was in fact much lower than expected, is that a sign of improvement? Not in the real world, I think. According to some predictions, it may take several years for the housing market to stabilize, so expecting a “quick rebound” in the coming months is somewhat unrealistic. A rosy picture from the NAR again? Perhaps…

Spike in mortgage rates

Rates on 30-year fixed mortgages rose again in the week ending May 31, 2007. The 30-year fixed-rate mortgage averaged 6.42%, up from 6.37% a week ago. 15-year fixed-rate mortgages climbed up as well, to 6.12% from 6.06% last week. 5-year hybrid adjustable-rate mortgages were at 6.19%, up from 6.02%. The 1-year adjustable-rate loan was the only type of mortgage to decline, with an average of 5.57%, down from 5.64%. Last year this time, the 30-year mortgage rate was 6.67%. 15-year fixed-rate mortgages and 5-year adjustable-rate loans carried an interest of 6.26%, and 1-year adjustable-rate loans were at 5.68.

Freddie Mac attributed the rise in interest rates to improving business and consumer spending, which are signs of a strong economy – outside of the housing market. Rates are currently at the highest level in 8 months.

Whatever the reasons, rising interest rates bode nothing good for the housing market. With higher mortgage rates come bigger monthly payments, which means that fewer buyers will be able to afford new homes. Considering the already existing glut on the market, a recovery in the near term seems impossible. The National Association of Realtors and the MBA pushed back their forecasts for a rebound in the Real Estate industry from mid-2007 to early 2008.