The Mortgage Market's Last Hurrah
The Federal Reserve's decision yesterday not to reduce its bond purchases sent the financial markets soaring, with stocks hitting new record highs and bond yields plunging. Yet one of the biggest winners of yesterday's non-move were mortgage lenders, which should get at least one final burst of mortgage activity as a result.
The fine print of QE
"Quantitative easing" sounds like a sophisticated concept, but in essence, it's pretty simple. The Fed buys bonds to keep demand up, boosting prices and lowering rates. Initially, QE focused only on Treasuries, whose rates indirectly affect all types of bonds. But its more recent inclusion of mortgage-backed securities had a more direct downward impact on the mortgage pricing and rate-setting.
Amid fears that the Fed would pull back on its $40 billion-per-month purchases of mortgage-backed bonds, rates in the mortgage market started spiking upward. That in turn hurt businesses that relied on healthy mortgage demand. Yet yesterday's surprise decision to sustain QE will likely lead to one last hurrah for mortgage-related businesses.
2 sets of winners
We've already seen one big bounce from yesterday's move: Real-estate investment trusts that invest in mortgage-backed securities experienced huge gains. Annaly Capital and American Capital Agency both climbed about 5% as investors equated climbing bond prices with increases in the book value of their existing mortgage-backed securities portfolios, reversing at least part of their recent declines.
Interestingly, Annaly and American Capital Agency face a conundrum. In one sense, higher long-term rates would help them, as increased spreads between short-term borrowing costs and long-term income would boost their profitability. Moreover, rising rates can lead to less prepayment activity, making their bond portfolios more stable. Yet with such massive existing portfolios, rising long-term rates hurt the value of the bonds they already own, offsetting future gains.
Meanwhile, mortgage lenders didn't see nearly the jump that mREITs experienced: Bank of America , JPMorgan Chase , and Wells Fargo only managed to post increases in the neighborhood of 1%. Wells and B of A were able to overcome higher interest rates in the second quarter to post higher mortgage-origination volume than in the previous quarter. Subsequently, though, JPMorgan and Wells said their third-quarter volumes look a lot uglier.
To some extent, banks enjoy benefits from wider spreads between short-term and long-term rates as well. B of A saw net interest income fall about 20% between 2010 and 2012, in part because lower long-term rates spurred by QE cut those spreads. JPMorgan and Wells also saw net interest income declines, although Wells did a better job than its peers of keeping its loan income levels relatively high.
For lenders, even a brief decline in mortgage rates should spur some last-gasp activity from borrowers seeking one last bite of the low-rate apple. The speed with which rates rose shell-shocked some would-be refinancers and home-buyers from moving quickly enough to avoid higher borrowing costs, and some likely waited in hope of seeing better conditions. They've now gotten their wish, and so as long as Fed-induced falling rates persist, banks should see one more bump in activity to boost their bottom lines.
A matter of time
Most investors recognize that the Fed's move only delays the inevitable pullback of its quantitative-easing program, so the long-term prospects for mortgage REITs and lenders remain cloudy. But at least in the short run, investors should see a final burst of good news before longer-term trends assert themselves once and for all.
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The article The Mortgage Market's Last Hurrah originally appeared on Fool.com.Fool contributor Dan Caplinger owns warrants on Wells Fargo, JPMorgan Chase, and Bank of America. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.