Pay no attention to those stories about "Shadow Inventory"! Apparently that has all been soaked up. Or, at least, builders and the NAR would like to believe that. It is hard to pick the top or bottom of any market, but it is hard to argue that housing prices are still heading down. Even the USA Today ("McPaper") headline today was about improving housing prices. The most recent Residential Price Index from FNC reveals that prices for non-distressed homes rose for a consecutive six months to hit their 20-month peak as of this August.  They increased a mere 0.3% from July but year-to-date has increased 5% from January, which reflects the overall strengthening of the housing market.  Not only is purchasing activity on the up, foreclosure sales dropped from 23% to 17.4% over that same time period.  Of the 30 metropolitan areas tracked by the index, those in the Western U.S. had the highest month-to-month price improvement, with prices in Los Angeles, Phoenix, and Sacramento all increasing more than 2% from July to August 2012.  The Phoenix area, which has pretty strong momentum at this point and has been hailed as leading the housing recovery, also displayed the strongest year-to-year growth, with prices improving 13.3%.  There's a trend towards positive year-to-date movement all over the country, however, as is revealed by price increases in places like Detroit, San Francisco, and Washington D.C.

The Commerce Department reported that Housing Starts surged 15% in September to its fastest pace in more than four years signaling that the housing sector's recovery is gaining some momentum.  Starts grew by 872,000 units on an annualized basis, well above the 768,000 expected.  Building Permits, a sign of future construction, increased by more than 11% to 894,000 units annualized, above the 815,000 expected.  Even RE/MAX reported that home prices have increased from levels since last year with median prices gaining 7.8%. In addition, inventory levels have declined by 29% since last year.  The lower inventories have actually spurred on bidding wars in certain sectors around the nation.

And over the last few months the National Association of Realtors (NAR) has been making some general statements that tight inventories of existing homes are "in some locations" impacting home sales. And this week the California Association of Realtors (C.A.R.) confirmed that they are one of those locations. C.A.R. said that "A continued shortage of available homes for sale lowered California home Sales in September, while the median price reached the highest level in more than four years." Catch the wave - buy a non-owner! Why not - the cash in most bank accounts is earning 0%.

"Rob - you really showed your age yesterday in your write up about gfees. Not the write-up itself, but in your note about the buy up ratio. You mentioned 2:1 or 3:1 - that was when dinosaurs roamed the earth. Try Freddie and Fannie charging lenders - and therefore borrowers - 7:1 or 8:1. So a gfee of 40 basis points will cost about 3 points to buy it down to 0, and allow a 3.25% loan to be put into a 3% security. Fortunately 3% Fannie & Freddie MBS are priced around 105 because the government is buying all our production, so there is some room to play."

Which brings up the question, "Who is buying all those mortgages that LO's are churning out, and what are they buying?" The Treasury International Capital (TIC) report for August showed strong demand for dollar assets from foreigners. Foreign inflows into Treasuries totaled +$43 billion, while corporate bonds and stocks saw +$11 billion and +$6 billion in inflows, respectively. The inflow into US corporate bonds was the strongest since July '08. In Mortgage Land, which some say is between Candy Land and Nowhere Land, in August agency debt and MBS held overseas increased by $18.6 billion, which consisted of a $17 billion increase in MBS holdings and a $1.5 billion increase in debt holdings. This was the largest increase in Agency holdings so far this year.  Within the MBS sector, the $17 billion in net purchases was offset by $14 billion in estimated prepayments, resulting in a net increase of about $3 billion in MBS holdings after accounting for prepays. Asia accounted for over $12B in net purchases in August, while Europe was also a large contributor with net purchases of $8B, mostly out of the United Kingdom and Luxembourg. (Shouldn't they be using that money to buy their own debt - like we do?)

Good LO's and well-run companies are continuing to say that demand is robust for home loans. But few banks want huge amounts of 30-yr fixed rate paper on their books. The yield curve is pretty flat right now (20-year rates are only about 175bp greater than 5-year rates). Banks know, however, that long-term fixed-rate lending is at fundamental odds with its asset/liability structure. (Put another way, when rates move higher and banks are paying depositors 4% on their money, they don't want to be earning 2.5% on the mortgage holdings.) Traders are seeing banks interested in interest rate swaps, since banks are compensated mostly for taking credit risk in the loan portfolio and not interest rate risk. An interest rate swap gives the borrower a fixed rate loan (stabilizing cash flow) while the bank enjoys a variable rate (better matching funding sources). Banks can continue to lend and earn fees, so while the underlying benefit of loan hedging lies in mitigating interest rate risk the primary benefit is continued lending.

But what residential agency mortgage-backed securities is everyone buying? Perhaps rascally 2.5% 30-years, filled with sassy 2.75-3.125% loans? Or perhaps 3.0% 30-year MBS, filled to the brim with 3.25-3.625% loans? Or how about those ancient 3.5% pools, or even higher rates, with that big risk of paying off early? Maybe the borrower's whose loans fill those pools can't refinance! The markets like to watch who is doing what, and the Fed is happy to oblige us with transparency. Recently the Fed has increased purchases in 30-yr 3's at the expense of 3.5's. And Fed gross purchases for the week ending October 10 were about $15 billion, lower than the $19 billion the prior week. This decline largely reflects the effect of the Columbus Day holiday and purchases remains consistent with buying $4bn/day. The Fed increased its gross purchases of 30-yr conventional 3's to 53% of the total compared to 50% the prior week. This was accompanied with a decline in 3.5's to 6% from 9%. The overall share of 30yr conventionals remained steady at 60%. The Fed also purchased $150 million in Fannie 2.5's. The purchase share of Ginnie 30-yr 3's also increased slightly to 14% from 13% the week before, while 3.5's declined to 5% from 7%. The Fed continued to stay out of the Ginnie 15-year sector, but purchases of 15-yr conventional 2.5s stayed at 18% of gross purchases. Overall purchases of 15-yr conventionals were also steady at 21%, and for the first time the Fed purchased $150 million in Fannie 2's.

On the hedging side, traders report that the overwhelming hedge coupon of choice was the Fannie Fannie 3% with over 80% of 30-yr hedge activity in that coupon compared to over 90% last week.  The 30-yr 2.5% coupon has been slow to gain liquidity, and is less than 2% of hedge volume. No one wants to sell something they can't buy back!

Bank earnings continue to come in, and to no one's surprise, they're strong. Bank of America reported better than expected net profit of $340mm ($6.2B prior year), as it took hits for $1.9B in accounting adjustments, $1.6B legal expense related to Merrill Lynch and $800k in tax related charges. The bank reported revenue fell to $20.4B ($28.5B one year ago); mobile customers surpassed 11mm; had a 48% drop in provisions for credit losses; mortgage originations climbed 18% and small business lending jumped 27% YOY. U.S. Bancorp reported record profit of $1.4B, up 15.8% over prior year. Compared to the prior year, average total loans grew 7.3% (C&I up 19%, CRE up 21%); noninterest bearing deposits climbed 16%; NIM was 3.59% vs. 3.65%; allowance was 2.26% vs. 2.66% and the efficiency ratio declined to 49.1% vs. 50.0%. M&T Bank reported a 34c operating beat, benefiting from a surge in mortgage banking revenues (+$0.21) as well as lower credit costs (+$0.07). U.S. Bank reported operating earnings of $0.76 per share this quarter, ahead of both our estimate and the Street. The beat was driven by higher spread income (+$0.01) and core fees (+$0.03), partially offset by a higher provision (-$0.02) and expenses (-$0.01). Wintrust saw strong mortgage banking results drove a 3Q beat as operating EPS of $0.58 beat estimates.  Northwest's Umpqua reported 3Q12 EPS of $0.22, in line with consensus. Lower NCOs drove a lower provision relative to our expectations, and mortgage banking revenue was up over 50% q/q.

Interest rates have indeed slid higher. The smart money thinks they're going to slide right back down here in the states. But if the European debt situation is stable, or improves, Asia begins to heat up, or our economy starts to pick up unexpectedly, all bets are off. Yesterday, for example, we had stronger-than-expected Housing Starts and encouraging news on Spain, which led to heavy locks & originator selling, and eventually intra-day price changes. By the "traditional 3PM EST" close (when the futures market closes), agency MBS prices were worse about .375 in price and the 10-yr. was at 1.81%.

For thrills and chills today we have Initial Jobless Claims (expected to increase to 365k), Leading Economic Indicators (expected to improve) and the Philly Fed Survey for October. In the very early going rates have improved slightly, with the 10-yr down to 1.80% and MBS prices better by about .125.

Old Butch
John was in the fertilized egg business. He had several hundred young layers (hens), called 'pullets,' and ten roosters to fertilize the eggs. He kept records, and any rooster not performing went into the soup pot and was replaced. This took a lot of time, so he bought some tiny bells and attached them to his roosters. Each bell had a different tone, so he could tell from a distance, which rooster was performing. Now, he could sit on the porch and fill out an efficiency report by just listening to the bells.
John's favorite rooster, old Butch, was a very fine specimen, but this morning he noticed old Butch's bell hadn't rung at all! When he went to investigate, he saw the other roosters were busy chasing pullets, bells-a-ringing, but the pullets, hearing the roosters coming, would run for cover. To John's amazement, old Butch had his bell in his beak, so it couldn't ring. He'd sneak up on a pullet, do his job and walk on to the next one.
John was so proud of old Butch, he entered him in the Saint Lawrence County Fair and he became an overnight sensation among the judges.
The result was the judges not only awarded old Butch the "No Bell Piece Prize," but they also awarded him the "Pulletsurprise" as well.
Clearly old Butch was a politician in the making. Who else but a politician could figure out how to win two of the most coveted awards on our planet by being the best at sneaking up on the unsuspecting populace and screwing them when they weren't paying attention.
Vote carefully this fall, the bells are not always audible.