Trend of Higher Rates Continues and Discussing Yield Spread

Mortgage backed securities continue their recent trend of moving lower in price which increases mortgage rates. Recent economic data is pointing to a bottoming of the current recession which is moving investor money away from the safety of fixed income over to more risky equities. It appears that the green shoots theory of a quick economic turnaround is gaining momentum. Most lenders did reprice for the worse yesterday as the losses continued through close. So far this morning, MBS continue to fall breaking some key support.

We do have some economic data hitting the wires today. The first report to be released is the weekly Mortgage Bankers’ Association application index which tracks the monthly change in the number of mortgage applications at major lenders. An increasing trend in purchase applications would suggest a bottoming in housing which most economists agree must happen before our economy can truly rebound. Recent data on housing is pointing to a bottoming. The release of the index has indicated that the purchase activity rose 0.9% last week while the refinance activity rose 7.2%. This is one housing report that is yet to show sizable improvements in the purchase market.

Also out this morning is the ADP Employment report which totals the number of jobs lost or created on a monthly basis. ADP is a private company that handles payrolls for many companies across the U.S. Their report only covers private payrolls and excludes government jobs. This data set is always released on the Wednesday prior to the official government numbers on Friday. Historically speaking this report has not been taken too seriously among market participants but it is gaining more credibility. Expectations called for a loss of 320,000 jobs last month but the actual release has indicated a loss of 371,000. This is a substantial improvement from last month’s revised loss of 463,000 jobs. Even though this report is worse than expected, it is hinting at a bottoming of job losses which provides more ammo to the green shoots economists that believe our economy is on the path to recovery.

While on the subject of jobs, we also got the Challenger Job-Cut report which totals the number of corporate layoffs on a monthly basis. Recent reports have indicated less and less layoffs but today’s release indicated a sharp increase from last month’s 74,393 to 97,373. This report and the ADP report both take a back seat to the official Employment Situation report coming on Friday from the U.S. Department of Labor and so far this morning has had no impact on MBS.

The Treasury Department at 9am eastern announced the amount of the upcoming treasury auctions to be held next week. When our government lacks the cash to pay for government spending, they issue treasuries to borrow the money. With the huge deficit that our country is running, these auctions are being held almost every 2 weeks when in past years they would be held quarterly. The added supply of treasuries on the market will pressure treasury yields to move higher to attract new buyers. Since treasuries and MBS are both a fixed income debt investment, they tend to move in the same direction. Already this morning, the benchmark 10 year note has moved from a closing yield yesterday of 3.68 to currently trade at 3.75. This increasing treasury yield has applied pressure on MBS to move higher in yield as well this morning. The announcement has come in right on expectations with $37billion of 3 year notes, $23billion of 10 year notes and $15billion of 30 year bonds going to the highest bidder next week.

Next, the Department of Commerce released the Factory Orders report which shows whether orders at factories for both durable and non durable goods are increasing or decreasing. This data set shows how busy factories will be in the upcoming months. An increasing trend will suggest higher sales and higher profits which is positive for stocks and negative for MBS. May’s factory orders moved higher by 1.2% from the prior month, giving support to the economic rebound. The data has shown that factory orders continue to show signs of improvement beating expectations of a 0.9% decline to come in at a 0.4% increase. The better than expected data is being offset by the news that the improvement in orders is due to higher energy costs.

Our last data set this morning is the ISM non-manufacturing index which shows whether the non manufacturing segment of our economy is contracting or expanding. The Institute of Supply Management surveys 400 firms across the U.S. for their opinion of the strength of the non manufacturing sector. Readings above 50 indicate growth while readings below 50 indicate contraction. The last three releases has indicated that the rate of contraction is declining and expectations for this report is a continuation of that trend. June’s report came in at 47.0 and expectations for July is a reading of 48.2. The release has indicated a worse than expected reading of 46.4 showing signs that the non manufacturing sector of our economy is contracting further.

In a sign of how unpredictable things can be, following the release of the not friendly to MBS data on factory orders but friendly to MBS ISM data the stock market has moved considerably lower moving money into the fixed income sector. The benchmark 10 year note has moved to 3.65 after hitting 3.75 this morning and MBS have regained all the losses from this morning.

To continue a discussion from yesterday regarding good faith estimates and yield spread premium. New legislation wants to eliminate yield spread premium (YSP) which is indirect compensation that is paid to the loan originator based on the interest rate they secure for you. I quote on my blog par interest rates which would pay zero yield spread premium to the originator thus the reason you would be required to pay all costs including a point to secure that rate. If YSP is eliminated, than no cost loans and no point loans will go away. You as a consumer will lose the ability to decide whether you wish to pay closing costs or decide not to. Our current government is eliminating many consumer choices such as the ability for you to decide who appraises your home with the passing of the Home Valuation Code of Conduct and quite possibly the elimination of no cost loans.

Here is an example of the benefits of ysp. Let’s assume a particular client has excellent credit, mortgage amount of $200,000, home worth $300,000 and a rate of 6.5%. Let’s further assume that the loan amount started at $210,000 making the P&I payment $1327 and they only intend to stay in home for 1 ½ years. They could refinance today by paying closing costs including a point, totaling $5400 fees, to 5% making payment $1100. Now, does it make sense for this client to pay $5400 in fees to save (1327-1100) $227 per month. Well, $5400 divided by 227 gives a break even point of 23 months. So, if this client only intends to keep home for 18 months, it makes no sense for them to pay costs and get the 5% rate. Now, lets say they do a no cost loan at 5.875%. This would lower payment to $1183 but no costs would be charged to the client since the higher interest rate will compensate the loan originator enough money to pay the closing costs for the client and still make a profit. This also allows the home owner to take advantage of a lower interest rate and lower payment thus benefiting their family’s financial position and also the overall economy. A lower payment allows them to have more money to spend in the economy and by refinancing they are also allowing many people to keep their job. Here is a link to H.R. 1728. What are your thoughts regarding this topic?

Early reports from fellow mortgage professional are indicating that the par 30 year fixed rate conventional mortgage is in the 5.125% to 5.375% range for the best qualified consumers. In order to qualify for a par rate you must have a FICO credit score of 740 or higher, a loan to value at 80% or less and pay all closing costs including 1 point loan origination/discount/broker fee. If you are planning to access home equity, you should expect either a slightly higher interest rate or increased costs.