Crow sandwich for SD Realtor

[SD Realtor]

Okay guys… time for me to eat some crow… ever since I have started posting here I have always been steadfast in my assertions about rates tracking the 10 year or long bond yields.

Today I had a very long chat with a regional officer at Countrywide. He told me that the 10 year is still an effective means to track the trend or direction of mortgage rates. However he said that only the very highest grade of mortgages will track the 10 year more or less spot on. That is, credit scores in the high 700’s with at least 20% down.

The problem as many of you have already pointed out is the secondary market. As the secondary market falls apart, lenders have to offer a much better risk premium to sell the loans. As more and more hedge funds, cdo’s etc fall apart, these premiums will grow and grow. This will continue until lending the secondary market regains confidence in the underwriting standards of originators, the ratings agencies redeem themselves, and the risk in the secondary market is unwound. This is going to take awhile.

So the post last week that was made about rates going up was correct. Rates are going up but not because of the 10 year or long bonds. In fact the 10 year rally is helping to mitigate the risk premium being added to anything but the highest grade of loans.

Again, the biggest unknown is how high will these premiums get? The Countrywide officer did not seem to know. He said it all will be determined by the demand on the secondary market to satisfy the supply from originators.

[patientrenter]

SDR, you say that “rates are going up”, but as you point out elsewhere in your post, they are going up only for lower-grade mortgages. (Agreed, most mortgages written in 2006 and 2005 and 2004 were in this category, but there are other kinds of low-risk mortgages still available.)

Here’s my take on rates for mortgages. It’s based solely on looking at the investment side. I’ve never borrowed money, so I don’t have a clue what a real actual mortgage looks like.

Class 1: Mortgages that get sold to GNMA, FNMA.. Rate = Treasury + Extra 1

Class 2: Mortgages that are conservatively underwritten but are not sold to the agencies. Rate = Treasury + Extra 2

Class 3: Mortgages that are aggressively underwritten. Rate = Treasury + Extra 3.

Extra 1 won’t change much, because of the explicit or implicit full faith and credit guarantee against default provided by the taxpayers, thanks to Congress.

Extra 2 will increase by a decent but not ridiculous amount. (I don’t know, I’d need to think hard, but maybe 20bp for a 20% down, 30% DTI, fully doc’d loan, increasing to 50-100bp for weakening of any one of these conditions.)

Extra 3 will increase by hundreds of basis points. Some forms of these loans will go extinct because the price is so high it’s unattractive to even the most irresponsible buyers, but others will continue to be available, at the higher price.

Patient renter in OC

[patientrenter]

SDR, you say that “rates are going up”, but as you point out elsewhere in your post, they are going up only for lower-grade mortgages. (Agreed, most mortgages written in 2006 and 2005 and 2004 were in this category, but there are other kinds of low-risk mortgages still available.)

Here’s my take on rates for mortgages. It’s based solely on looking at the investment side. I’ve never borrowed money, so I don’t have a clue what a real actual mortgage looks like.

Class 1: Mortgages that get sold to GNMA, FNMA.. Rate = Treasury + Extra 1

Class 2: Mortgages that are conservatively underwritten but are not sold to the agencies. Rate = Treasury + Extra 2

Class 3: Mortgages that are aggressively underwritten. Rate = Treasury + Extra 3.

Extra 1 won’t change much, because of the explicit or implicit full faith and credit guarantee against default provided by the taxpayers, thanks to Congress.

Extra 2 will increase by a decent but not ridiculous amount. (I don’t know, I’d need to think hard, but maybe 20bp for a 20% down, 30% DTI, fully doc’d loan, increasing to 50-100bp for weakening of any one of these conditions.)

Extra 3 will increase by hundreds of basis points. Some forms of these loans will go extinct because the price is so high it’s unattractive to even the most irresponsible buyers, but others will continue to be available, at the higher price.

Patient renter in OC

[SD Realtor]

PR I don’t think I said that rates are going up. My main concern is the uncertainty with the risk premiums that will be built in by the lenders. Your post makes good sense except that I am pretty sure a very high percentage of loans are sold on the secondary market. Even those in the class 2 example. Even so called direct lenders must resell loans otherwise they could not continue to do business. So basically I agree with your posts and my point is that Extra 1, Extra 2, and Extra 3 will be totally driven by the secondary market. It will be interesting. I think your numbers make good sense for now. Let’s see how they hold up.

SD Realtor

[SD Realtor]

PR I don’t think I said that rates are going up. My main concern is the uncertainty with the risk premiums that will be built in by the lenders. Your post makes good sense except that I am pretty sure a very high percentage of loans are sold on the secondary market. Even those in the class 2 example. Even so called direct lenders must resell loans otherwise they could not continue to do business. So basically I agree with your posts and my point is that Extra 1, Extra 2, and Extra 3 will be totally driven by the secondary market. It will be interesting. I think your numbers make good sense for now. Let’s see how they hold up.

SD Realtor

[patientrenter]

SDR, if you read your own post starting this thread, you will indeed find yourself saying “rates are going up”, but it doesn’t really matter because we both agree that it’s more complicated than that. Some rates are going up and some are going down. We’ll see how that all plays out.

I agree with your comment that the pricing of securitized loans drives consumer loan pricing. In my job, I review investments that include a fair number of securitized loans and their derivatives, so I have a general familiarity with them and how they compare against other bonds. But my knowledge of the underlying loans is limited, because I only know them indirectly from my exposure to the securities.

I should have added another condition to my benchmark loan for Class 2, namely level fully amortizing payments at fixed interest rates.

For Extra 1, I should also have added the expected (non-panic) level of extra losses on conforming loans. This shouldn’t grow much in the near future. FNMA has a choice: Keep the extra rate charged to mortgageholders for future defaults low, based on non-panic long-term non-market asumptions, or lose the favor (and guarantee) of the govt. Only one right answer. Could go higher later if the housing market goes really bad for a few years.

Patient renter in OC

[patientrenter]

SDR, if you read your own post starting this thread, you will indeed find yourself saying “rates are going up”, but it doesn’t really matter because we both agree that it’s more complicated than that. Some rates are going up and some are going down. We’ll see how that all plays out.

I agree with your comment that the pricing of securitized loans drives consumer loan pricing. In my job, I review investments that include a fair number of securitized loans and their derivatives, so I have a general familiarity with them and how they compare against other bonds. But my knowledge of the underlying loans is limited, because I only know them indirectly from my exposure to the securities.

I should have added another condition to my benchmark loan for Class 2, namely level fully amortizing payments at fixed interest rates.

For Extra 1, I should also have added the expected (non-panic) level of extra losses on conforming loans. This shouldn’t grow much in the near future. FNMA has a choice: Keep the extra rate charged to mortgageholders for future defaults low, based on non-panic long-term non-market asumptions, or lose the favor (and guarantee) of the govt. Only one right answer. Could go higher later if the housing market goes really bad for a few years.

Patient renter in OC

[michael]

It’s called credit spread. Nothing new. From Investopedia

1. The spread between Treasury securities and non-Treasury securities that are identical in all respects except for quality rating.

Looking at history, there will be periods where spreads are tight and others where they are wide. The world is a whole lot bigger than mortgage lending. The big boys in the bond market have been doing this for decades. They run the show.

Nothing new.

[michael]

It’s called credit spread. Nothing new. From Investopedia

1. The spread between Treasury securities and non-Treasury securities that are identical in all respects except for quality rating.

Looking at history, there will be periods where spreads are tight and others where they are wide. The world is a whole lot bigger than mortgage lending. The big boys in the bond market have been doing this for decades. They run the show.

Nothing new.

[Author]

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