May 9: Economic trends LOs should be aware of; primer on servicing values: what is the cash return?

It will be interesting to see if the coronavirus pandemic convinces people to move back out of cities. (Speaking of cities, and living in captivity, thank you to Jennifer W. who sent along this collection of fun/clever videos: “The 4 Weeks of Quarantine” – there are sure some creative people out there.) The U.S. Census Bureau revealed that over half (53.6 percent) of U.S. counties were smaller in 2019 than they were in 2010 as people consolidated in major metropolitan areas. These patterns of growth or decline were largely related to county size, with most small counties losing population this decade and most large counties gaining. Of the 3,142 counties in the nation, six of the 10 displaying the most population growth were in Texas (Harris, Tarrant, Bexar, Dallas, Collin, and Travis) while the other four were in the West (Maricopa County, AZ; King County, WA; Clark County, NV; and Riverside County, CA). Phoenix broke into the top 10 largest metro areas, as Boston dropped out. More on the economy below.

Servicing: Why the Attraction?

Of course banks like servicing monthly mortgage payments as it helps maintain or create customer relationships. What about independent, non-bank mortgage banks: is there money to be earned over the months and years of servicing a loan? Following last Saturday’s write up on servicing values, I received this question. “Rob, I understand the concept of the servicer receiving a little money every month from each loan it services. But I’ve also heard that some amazing returns may be available, like 10-30 percent. How is that even possible? Can companies still borrow money to increase their servicing portfolio size?” For a solid answer I turned to STRATMOR’s Seth Sprague, who explained how companies see those returns.

“MSR investors often measure the return of the MSR asset in several ways including return on asset, return on equity and for banks return on risk weighted assets. It is important to remember that the MSR asset is recorded initially at its fair value representing the net present value of the expected servicing revenues components less anticipated servicing expenses adjusted for prepayment speeds and delinquencies. The net is the discount rate or estimated yield of the MSR value. As the MSR values (the multiple or price obtained from either aggregators or co-issue buyers) has declined, the MSR yield has increased, remember yield represents risk! If the Pre-COVID MSR expected return was in the 9% to 12% range (pre-tax un-levered yield), the yield has certainly widened today, but the risks to the servicing cash flows has also changed dramatically.

“One of my preferred methods to view MSR returns and where I spend a lot at time at STRATMOR helping folks is tracking and understanding the actual cash return of the MSR asset. The cash return includes all the cash revenue items less all the cash expense items, plus or minus the advances made. The cash view eliminates much of the noise of the MSR Accounting. For originators who are now retaining MSRs as a result of the lack of aggregator demand or the collapse of the co-issue market, it is imperative that companies understand the true cash implications of retaining servicing and stress those assumptions around prepayments, forbearances, and delinquencies. As I have joked with clients, it is hard buy anything from Amazon using MSRs……if the MSR asset is not net cash flow positive, it is difficult to retain, especially for non-depositories.

“On the MSR financing side, the MSR financing facilities are still open, however lenders only permit MSR holders to borrow up to a certain percentage of the overall MSR value. With the decline in MSR values, there is less cash available today than Pre COVID levels, however MSR financing lines remain open.” Thank you, Seth!

“It’s the economy, stupid”

I wanted to share the latest update on Moody’s Investor’s Service forecast for the global economy. Moody’s now expects the G-20 advanced economies as a group to contract by 5.8 percent in 2020. Even with a gradual recovery, Moody’s expects 2021 real GDP in most advanced economies to be below pre-coronavirus levels. The following were some of Moody’s key messages. The U.S. GDP is expected to contract by 5.7 percent and the euro area to contract by 6.5 percent this year. China’s economy is forecasted to grow by 1.0 percent in 2020, followed by 7.1 percent growth in 2021, partially reflecting a revival in demand from its trading partners. Moody’s forecasts assume a gradual recovery in the second half of the year as the spread of the coronavirus declines and restrictions on business activity ease, though that accounts for recurring and localized lockdowns within various countries at various times.

Renewed nationwide lockdowns would lead to far worse economic outcomes than Moody’s assumes in its baseline forecasts. Such a scenario would result in severe harm to the real economy, with potential for the shock to quickly escalate into a deep financial crisis that would be far worse in scale and scope than the 2008-09 global financial crisis. This shock could fundamentally change consumption patterns, such as travel, that could lead to a large-scale reorganization of economic structures over time. There is likely to be a great deal of destruction in sectors such as leisure, hospitality, travel, and retail. As individuals and business adapt to social distancing, nature of work and delivery of services could permanently change in certain sectors.

The National Association of Federally-Insured Credit Unions (NAFCU) Chief Economist and Vice President of Research Curt Long issued the following statement after the Fannie Mae Home Purchase Sentiment Index (HPSI) decreased an additional 17.8 points in April to 63.0: “Sellers are understandably reluctant to list homes right now. The lack of supply should provide support for prices. But elevated concerns over job loss and income declines are suppressing demand, and that is likely to last even after states begin to reopen.”

Shutdowns and shelter-in-place decrees have ground economic activity to a virtual halt across the country, and large cities where housing demand was the strongest have been hit the hardest. Economic forecasts have been ratcheted down considerably as a result. GDP for 2020 is expected to be the worst since WWII and unemployment is predicted to rise towards nine percent, with over 15 million people filing for unemployment benefits over the last three weeks.

Both new and existing home sales are expected to post double-digit year-over-year drops in March and April. The declines mark a sharp reversal from months prior, as home sales had gotten off to a strong start this year, aided by strong job growth, low mortgage rates and mild winter weather. Sales of new homes through February were running 21 percent ahead of the same pace last year and sales of existing homes were up 7.2 percent year-over-year in February. The latest mortgage applications data, which offers an early look as to how the housing market is likely to be impacted, have fallen off dramatically after hitting an 11-year high just a month ago.


Housing is positioned to be one of the driving forces of the economic recovery. Housing starts ramped up late last year, reflecting strong demand from first-time buyers. Starts averaged a whopping 1.61 million-unit pace over the past three months, which is 24.7 percent above last year’s total of 1.29 million units. Builders are expected to remain relatively busy in the coming weeks, even as sales weaken. Home construction is deemed an essential activity in most communities that have enacted shelter-in-place orders, and most work can be done in ways that are consistent with CDC social distancing guidelines.

Prospective buyers, however, will face a little more difficulty shopping for homes while they are sheltering in place, and builders will likely not want to get too far ahead of demand, particularly with the unemployment rate spiking. Housing starts are unlikely to fall too much, however, as housing is severely under built across the country. The most recent estimates have single-family starts falling 0.9 percent this year, with most of the drop coming over the next few months. There still appears to be significant pent-up demand for homes from the rising number of Millennials reaching their late thirties.

Apartment construction is likely to take a bigger hit. While most of the growth in the apartment market this past decade has been in higher-end luxury units, apartment development had been pivoting toward more affordable units it recent years, targeting the hourly wage earners that are most likely to bear the brunt of the impact from coronavirus-related shutdowns. Multi-family starts are expected to decline by a sizable amount this year. With the unemployment rate spiking, apartment owners are likely to be focusing on operations rather than new development, and new projects will also likely face greater scrutiny from investors and lenders.

Even before the pandemic began in earnest, total construction spending fell 1.3 percent during February, as residential (-0.6 percent) and nonresidential (-1.8 percent) activity both slipped. The drop does follow a massive 2.8 percent jump in construction spending in January. The February data offers a glimpse of what is likely ahead in coming months. While many projects appear to be moving forward, several hard-hit areas have already suspended all construction or are beginning to close down sites. A wide array of building materials is imported from virus-embattled countries, and supply chain disruptions may be apparent in the U.S. for quite some time. To be sure, construction should fare better than other industries like hospitality and retail trade. Many infrastructure, hospital and residential projects are considered essential and should continue even in the areas with severe outbreaks.

With the Federal Reserve cutting the fed funds rate to 0-0.25 percent, some consumers were led to believe that mortgage rates are heading there, too. That is not only not true, but not happening any time soon. You can think of the 30-year mortgage rate as a combination of the 10-year Treasury rate plus a spread that makes it worthwhile for the bank to lend the money, covering the bank’s operating costs and generating a profit. Without a spread over its own cost of funds, a lender could not continue to operate and fund loans. That is why mortgage rates are consistently well above the rate on the 10-year Treasury, historically 1.8 percentage points or so and currently around 2.5 percent. So why has that spread widened? One reason is that low rates have encouraged a massive wave of refinancing, overwhelming the ability of banks to keep up. In some cases lenders are actually raising their rates to make business more profitable. Others raise rates to discourage new business because their underwriters are too busy. Still, now remains a good time for many borrowers (millions, actually) to refinance their mortgage and reduce their monthly costs, especially as further economic uncertainty looms.

Have you had clients wondering why their mortgage rate has been impacted by others who have a forbearance on their mortgage? It’s a question worth an explanation. Let’s start with some background. When the CARE Act was signed into law, one of the provisions was that any borrower with a federally backed mortgage on a single-family property is eligible for a forbearance for up to 180 days if they request one from their lender (or servicer). The “federally backed” verbiage is key. Fannie and Freddie were taken over by the Federal Housing Finance Authority during the last financial crisis, meaning the U.S. Treasury backs all mortgages funded by Fannie and Freddie. As a result, the “risk” of default has been diminished to near zero thanks to this backing of the federal government.

As a loan officer, understand that when Fannie or Freddie buys loans from a lender, this comes with the expectation of cash flows from the borrower’s monthly payments. For lenders, selling loans provides capital to fund mortgages for borrowers. When a loan goes into forbearance, the lender servicing the loan has to continue to advance four months of payments for principal and interest until the loan is paid off or foreclosed on. This is really hurting lenders servicing loans, as the lenders are forwarding four months of payments on mortgages for which they are collecting no payments, cutting deeply into their liquidity. Those payments that must be forwarded can no longer be used for funding other mortgages or any expenses the company incurs. Because lenders servicing loans have to enable a forbearance on any single-family mortgage that is back by the federal government, lenders do not want to make a loan today that will become a forbearance later in the month, or next month or the month after, since it takes a lender about a year of collecting payments to recoup the cost of originating and funding a mortgage. So, what is the end result? Lenders look to mitigate risk by doing one or a combination of raising rates, lowering maximum loan amounts, and limiting loan programs that present higher risk in normal markets.

Captivity has taught me a lot. I’ve spent eight weeks hanging out with myself and the last two weeks apologizing to every person I have ever spent time with.

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Rob Chrisman