Thursday, June 11, 2015

Mortgage trends in 2015 Q1

Why can't anything be easy?  2015 1Q Flow of Funds data came out this morning.  I have been hoping for regulatory and market adjustments to allow for more expansion of mortgage expansion, which would help to push home prices back up to intrinsic values and would provide investment demand, pulling interest rates up.  The convergence of interest rates and returns to real estate would earn profit for a position short on bonds and long on housing.

But, real estate loans retained at the banks have stalled in the past month, and while mortgage levels measured by Flow of Funds had stopped declining, they have been level.  This is a little bit surprising to me compared to anecdotal information I'm seeing in the Phoenix area.  It's a sellers market, and households with decent credit seem to be able to mortgage new home purchases.  Home price growth has started to turn up again, but it seems like there is enough activity to trigger more new building and to push mortgage levels up.

In 2015 1Q, mortgage levels actually turned down again.  But, the re-acceleration of home prices, combined with the decline in mortgage levels, caused household real estate equity to jump a full point, from 54.6% to 55.6%.  Before the real estate collapse, equity levels had been ranging between 58% and 60%.  Maybe under the new regulatory and market pressures, equity levels will tend to be higher, so that there isn't anything special about hitting that range.  But, it seems like some sort of signal of healing markets, if only because it would suggest that households would be less encumbered by negative or negligible home equity levels that prevent refinancing and home selling.

I don't have any direct evidence of a connection between foreign capital and these movements, but it does seem fitting that a large part of the decline in 2015 1Q GDP came from a larger trade deficit.  That suggests that there was a surge of foreign capital, which could be the source of price strength in housing without any domestic mortgage growth.

This complicates the housing/treasuries position.  The foreign capital will probably affect prices more than new homebuilding.  If mortgages continue to stagnate, this means that the homebuilder portion of the position will probably have a delayed reaction, and highly leveraged homebuilders like Hovnanian will need to muddle through a few more quarters before there is a positive growth surprise.  On the interest rate side, this has less clear implications than mortgage growth would have had.  New housing value grows the capital base, but I'm not sure of the effect on interest rates.  It wouldn't have as strong of an effect on the investment/savings balance as new building would.  So, I am not sure if interest rates will fall back because of the lack of mortgage growth or if they will remain fairly stable or rise slowly.  The uncertainty has pulled me out of the interest rate position, but I'm afraid that I will watch the potential profits slowly accrue to that position as I watch from the sidelines.


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