Standard and Poor's Ratings Direct Service has made some projections for the coming year. In addition to numerical forecasts for the economy as a whole, house prices as reflected by the S&P Case-Shiller Indices, interest rates, and mortgage financing, S&P says that each part of the market will be affected one way or another based on the housing, economic, and political landscape of 2014. With this in mind they briefly discussed, in their U.S. Housing and Residential Mortgage Finance: 2013 Outlook some housing related sectors going into the new year and how the company views them from a ratings perspective.
Banks will continue cost-cutting as interest rates rise and mortgage activity moderates. Some large institutions have already reduced staff and pipelines have shrunk. S&P expects banks will continue to work through risky loans, minimizing charge-offs and non-performing assets which will also lower expenses for their servicers. They have also continued to negotiate with Freddie Mac and Fannie Mae (the GSEs) over repurchase claims which should translate into smaller reserve levels going forward.
Sales to the GSEs has declined because of increased competition from other originators and less investor interest in longer fixed-rate assets and rising rates will continue to shrink profitability. On the upside, rising home prices should enable some home owners to refinance and has turned consumer sentiment more favorable regarding home ownership. S&P expects a shift from refinancing to purchasing but with less volume overall. Banks will continue to put excess deposits into their loan portfolios and will continue underwriting jumbo mortgages, particularly adjustable rates ones for their balance sheets. Credit quality will continue to improve along with economic conditions and more stringent underwriting.
The future of Fannie Mae and Freddie Mac is still under discussion but it is clear that both the administration and Congress intend to wind them down and this year lawmakers introduced concrete plans to do so. Regardless of the timing or specifics of reducing the GSEs' role, S&P believes the government will continue to support their debt obligations and that they will continue to remain profitable in near-term. The GSEs will continue to focus on providing liquidity to the housing market, while shrinking their investment portfolios and building the infrastructure of a future housing finance market.
Municipal Housing Industry:
Housing issuers within U.S. public finance are more affected by decisions of the U.S. federal government than by the status of real estate markets. Housing finance reform may endanger the federal government's longstanding role in promoting affordability and austerity aimed at public housing has implications for housing availability and credit quality. S&P says it haven't noted changes in ratings because of declining federal support for housing but municipal issuers with federal guarantees should fare better than those reliant upon federal appropriations.
Affordable single-family housing ratings of housing finance agencies (HFAs) remain strong with 83 percent having AA- ratings or better compared to 75 percent before the downturn. Equity-to-assets ratios are at historical highs, nonperforming asset ratios are improving, and almost all HFAs have positive net income.
S&P expects multifamily housing to have better outcomes where there is strong federal support such a debt issues backed by GSE or Ginnie Mae or armed forces housing. Department of Housing and Urban Development (HUD) support is less certain; its funding declined by 12 percent between 2008 and 2012. Sectors with less federal support will be subject to more stress and their ratings will be more subject to market forces.
Housing finance reform is an issue for municipal issuers. The two main proposals increase down payment requirements to 5%, higher than the 3.5% of many affordable single-family loans offered by HFAs. Where an HFA provides down payment assistance, making up the difference could mean additional costs and could decrease their participation in the affordable housing market
Buyers took a step back in the first half of 2013, giving the market time to absorb and re-adjust to the market dynamics. Home sales and price appreciation were slowed by a combination of rapid price increases, higher mortgage rates, the government shutdown, and normal seasonal patterns. S&P views the moderation as healthy given the previous pace of growth, particularly of home prices and expects that homebuilders will still report strong revenue and earnings growth in 2013.
S&P also expects supply and demand fundamentals to remain good through 2013 with rising employment and expanding household formation supporting demand while low levels of construction constrain supply. The recovery in home building, however is fragile and it could take an uneven trajectory. S&P expects most builders to selectively use incentives to retain last years increased average sales prices. Revenue should be driven by new planned community openings and EBITDA growth over the next 12 to 18 months but it credit metrics will strengthen at a slower pace as builders borrow to meet growing demand and exhaust the large cash reserves that supported their ratings through the downturn.
In the S%P's view, 2014 should mark a return to profitability for the mortgage insurance (MI) sector, barring any macroeconomic setbacks. While their legacy portfolios continued to contribute losses in 2013, new notices of delinquency (NODs) are declining and claims severity is improving. The ratio of new vintages and their contribution to profits should continue to increase and lead to lower losses and improved MI performance.
The regulatory changes under consideration could be favorable for MIs. Negotiations with the GSEs on capital requirements could end the need to operate under capital waivers from state insurance regulators and they have recently finalized a Master Policy with the GSEs.
The increased insurance premiums and more stringent underwriting requirements of the FHA have, in the rating service's view, allowed MIs to gain market share. At the same time, however, the GSEs higher guarantee fees have effectively increased the price of mortgage insurance. Several MIs recently reduced premiums by 10%, which could help counter the guarantee fee increases. While the net effect of the changes for 2014 is uncertain, there could be some stabilization in these market shifts.
The high credit quality of new insurance and the improving housing market and economy should result in a profitable MI business and near-term capital accumulation. The recovery remains at risk and a new recession could reverse the declining trend of defaults and rising claims could prevent the MIs from raising the capital necessary to write new business through a downturn.
Residential mortgage servicers were focused in 2013 on complying with existing regulations and implementing the Consumer Financial Protection Bureau's (CFPB) final servicing rules. The new rules, which go into effect on January 10 (many of which concern default management) apply to all servicers and, S&P says, provide the industry with clarity going forward.
Residential servicers benefited from low mortgage rates in the first half of 2013. These led to refinancings of existing servicing portfolios, helping to lower run-off and retain customers. However, rising rates in the second half of the year led to lower refinancing volume and some servicers reduced staff.
Transfers of mortgage servicing rights (MSRs) continued in 2013, with many transfers going to nonbank servicers. Because MSRs are no longer considered Tier I capital holding the MRSs would have required holding additional capital. On the positive side, rising interest rates tend to raise the MSR values because they are associated with lower prepayment speeds so servicers with large MSR portfolios could realize higher mark-to-market gains although at a diminishing rate. Consolidation in the industry continues as nonbank servicers acquire mortgage servicing operations.
The CFPB will begin monitoring servicer compliance with its rules, and the national mortgage settlement monitor will expand its testing scope. Transfers of MSRs to nonbanks from banks will likely continue as will sales of servicing operations and portfolios as the CFPB servicing rules could raise barriers to entry for new servicers. Aggressive growth strategies might increase operational risks, as servicers must add and train staff, maintain systems, and focus on internal controls and compliance.
As portfolios run off, some servicers could begin to originate their own loans. Large bank servicers may continue to stop servicing defaulted assets to focus on servicing new originations. GSE reform may affect GSE servicers if it results in changes to their servicing standards. CFPB's final servicing rules could result in more consistency and perhaps better experiences for the borrowers, as the rules apply to all servicers.
Increasing interest rates lowered mortgage origination volumes in the second half of 2013 and these lower volumes will continue into 2014. Non-agency mortgage originations centered on high-quality prime jumbo mortgage loans and there was not a notable decline in the quality of these loans at year end. However S&P says that the diminishing population of high-quality prime jumbo refinance options, a larger portion of purchase activity, rising home prices, no increase in the conforming loan limits, and more favorable economic conditions, should lead to a greater emergence of jumbo mortgage lending.
New rules going into effect in January establish rules for the eligibility of a qualified mortgage (QM) and originators have invested in platforms and tooled their businesses to reflect these parameters. S&P expects non-agency securitization volume in 2014 to reach almost $40 billion, approximately 30% higher than the 2013 forecast of $29 billion. About two-thirds of the total will be prime jumbo originations and the remainder GSE risk-sharing transactions and less-traditional securitizations, such as REO-to-rental. "Although mortgage rates have gone up and the wave of refinancing activity in 2013 has fallen, the 2014 lending landscape...bodes well," the report says.
On a more general basis S&P expects its Case-Shiller 20-City Home Price Index to rise by 6 percent from December 2013 to December 2014, half the pace of the previous year. Unemployment will fall below 7 percent and there will be real GDP growth of 2.6 percent. The company expects a shift in mortgage products toward adjustable rate mortgages in the new year and projects the 30-year fixed rate mortgage at 4.6 percent in the fourth quarter compared to 4.2 percent in Q4 2013.
The ratings firm says that the availability of mortgage financing remains the lynchpin as we hover around a 64% home-ownership rate. The GSEs and Federal Housing Administration (FHA) continue to be responsible for buying or insuring most new originations, and the lower-than-average homeownership rate and swarm of investor purchases of the last 18 months might or might not be a long-term model for U.S. housing. This model also relies on a substantial U.S. government guarantee which is not a popular option among the various housing finance proposals under consideration.