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As mortgage rates hit a 22-year high and existing homeowners continue to stay in their homes, new single family home sales hit a 17-month high in July, according to HUD and U.S. Census Bureau data.
Last month’s data recorded a seasonally adjusted annual rate of 714,000 new single-family home sales, up 4.4% from the revised June rate of 684,000 and is 31.5% above the July 2022 estimate of 543,000. The median sales price of new houses sold in July 2023 was $436,700 and the average sales price was $513,000. First-time buyers now make up 50% of all buyers, up from 45% in 2022 and 37% in 2021.
Chief economist at the National Association of Realtors, Lawrence Yun, said he expects rates will begin decreasing by the end of the year, citing the Fed’s slowing of its interest rate increases. The Mortgage Bankers Association, said they expect the average 30-year mortgage rate to decrease to 5% by the fourth quarter of next year.
Meanwhile, Morgan Stanley reiterated concerns for regional banks. Vishy Tirupattur, its Chief Fixed Income Strategist, said the firm does not accept a growing narrative that “the issues in the sector that erupted in March are largely behind us.” “The ratings downgrades by both Moody’s and Standard & Poor’s,” Tirupattur said, “provide a reminder that the headwinds of increasing capital requirements, higher cost of funding and rising loan losses continue to challenge the business models of the regional banking sector.” While acknowledging that comment periods are open and changes could occur, on the heels of proposed rules around capital requirements, the Fed’s proposed capital rule on implementing capital surcharge for the eight U.S. global systemically important banks, and proposed regulations on new long term debt requirements for banks with assets of $100-700 billion, Tirupattur said “suffice to say that the documents envisage significantly higher capital requirement for much of the U.S. banking sector, and extends several large bank requirements to much smaller banks.”
In short, Morgan Stanley argues the result — supported by the latest Senior Loan Officer Opinion survey and a paper by the San Francisco Fed evaluating regulatory impacts on the real economy — is tighter credit going forward. “The bottom line is that more tightening lies ahead for the broader economy,” . …[and] “the evolution of regulatory policy can weigh on credit formation and overall economic growth.”
A report by Newmark in the Commercial Observer said debt origination volumes in the sector fell 52 percent year-over-year in the second quarter. They said there are also 32 percent fewer lenders than a year ago and lenders have grown “more selective in recent months, demanding lower loan-to-value ratios amid the Federal Reserve’s interest rate hikes.”
Additionally, the Washington Post ran a story this week about what is being referred to as the “urban doom loop” affecting midsized cities if commercial real estate headwinds persist. “The fear is that a commercial real estate apocalypse could spiral out and slow commerce, wrecking local tax revenue in the process. Midsize cities have some of the highest rates of office delinquency, where loan payments on buildings are behind schedule, and the lowest rates of office occupancy,” the Post reported. “The average delinquency rate across the 50 largest metro areas in the country is about 5 percent. But in places like Charlotte in North Carolina or Hartford in Connecticut, it is almost 30 percent, according to data from the real estate analytics company Trepp. Likewise, occupancy rates average about 87 percent. But in Oklahoma City, it is just 71 percent, and 76 percent in both Memphis and St. Louis.”
As the market was expecting, the Fed raised interest rates another quarter point Wednesday afternoon, bringing the federal-funds rate to a range between 5.25% and 5.5%, a 22 year high. There will be eight weeks until the next Fed meeting.
Chairman Jay Powell said there is “uncertainty in the next meeting let alone next year.” Powell also said he believed they “have a shot” at a soft landing in the economy — the ability to achieve inflation reduction without high levels of job loss as has occurred in many past instances of tightening. We’ve been hearing this from some (not all) Wall Street economists more recently, but during the press conference Powell also revealed the independent staff at the Fed is now no longer forecasting a recession, given recent strength in the economy.
Asked directly about the housing market and the prospect of getting supply and demand back into balance, Powell said, citing the constraint of existing homes, “I think we have a ways to go to get back to balance” given that existing homeowners with low rate mortgages see “too much value in their mortgage,” keeping supply tight and continuing to pressure prices. On the other hand, Powell said, even in this rate environment there are a significant number of new buyers. “Hopefully,” Powell said, “more supply comes online” and “we are still living with through aftermath of the pandemic.”
The Mortgage Bankers Association (MBA) said high mortgage rates and low existing inventory led to another annual increase in new home purchases in June. Mortgage applications for new home purchases jumped 26.1% in June from the same period last year, according to the MBA’s builder application survey. Compared with the prior month, applications dropped by 5%, MBA said.
Housing Wire reported that construction of single-family homes specifically designed as rentals is booming. However, there are several states bucking that trend due to regulatory constraints that make investment less attractive.
The shift in commercial real estate since the pandemic — decreased office occupancy and retail activity coupled with higher interest rates — has put the CRE sector under continued strain. That stress has caused banks and other lenders to tighten their standards for new loans and scrutinize existing ones. Reuters reports that big banks are increasing loan loss reserves for commercial real estate although their exposure is relatively low. “While regional banks carry the greatest exposure to the (CRE sector,” Reuter said, “second quarter earnings show that a number of big banks have prepared for potential defaults, primarily on office loans.”
Mortgage and housing trade groups meanwhile this week objected to the Financial Stability Oversight Council (FSOC) proposal to designate nonbank servicers and others as systemically-important financial institutions. MBA said in a letter response that FSOC’s proposed interpretive guidance and a revised analytical framework “signal a renewed effort by the Biden Administration and federal financial services regulators to target non-bank financial companies – including non-bank mortgage servicers – for SIFI designation and subject them to Federal Reserve prudential oversight.”
MBA also reported that Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) may vote Thursday on the interagency proposed changes to capital requirements for banks with assets of $100 billion or more, which may include an increase in residential mortgage capital requirements for large depository banks. “This is disconcerting,” MBA said, “as large increases in capital standards will likely lead to a shift in where mid-sized and regional banks will focus their core businesses and reduce credit availability for all types of lending, including for single-family, multifamily, and commercial real estate.”
Amidst somewhat surprising signs of resilience this year in the U.S. economy, Fed watchers expect two more rate hikes this year to combat stubbornly high core inflation rates. Goldman Sachs Research’s chief U.S. economist believes a healthy labor market rebalancing that includes a large decline in job openings without an increase in unemployment is a positive sign for the potential for the U.S. to orchestrate a softer landing.
Although initial jobless claims and layoff rates are ticking up, the labor story has a positive side to it — wage growth appears to be coming down, dampening its inflationary pressures, the Goldman Sachs Research group said. Additionally, supply chain problems that recently vexed the economy are continuing to heal, leaving room for rebuilding of inventories that should be deflationary.
Within housing, the dichotomy between existing and new homes construction continues. The National Association of Realtors said existing home sales fell 20.4 percent year-over-year in May, the large annual decline in 11 years. MBA reports that after the 2021 market had set records for purchase ($1.86 trillion) and refinance originations ($2.57 trillion), originations fell to an estimated $2.2 trillion in 2022, and are forecasted to fall further to $1.8 trillion this year. Fannie Mae lowered its 2023 Single-Family Originations Forecast to $1.59 Trillion.
The National Association of Home Builders/Wells Fargo Housing Market Index reported that “solid demand, low existing inventory, and improving supply chain efficiency shifted builder confidence into positive territory in June for the first time in 11 months.” Home construction surged in May and prices of new homes have ticked up, even with interest rates at a 15-year high, surprising some analysts.
Zillow recently issued a report that suggesting there is a deficit of 4.3 million homes, with “roughly 8 million individuals or families who lived in another person’s home in 2021 and just 3.7 million homes for rent or sale.”
Fed Chairman Jay Powell is on the Hill delivering the Fed’s semiannual report on monetary policy to the Senate and House. He told the House Committee the Fed is likely to raise interest rates in the coming months but at a slower pace than they have moved over the past year, weighing the risk that the combination of their 10 consecutive rate hikes and recent banking stress is more than enough to slow the economy to tame inflation (perhaps causing an deeper economic downturn than expected) against the risk that the combination of economic strength of the first two quarters and inflation staying elevated may require additional tightening. Powell pushed back on the notion that last week’s pause was indeed a pause, signaling the Fed will not hesitate to take future action on inflation.
In the absence of recent negative headlines around regional bank stress in the US, Morgan Stanley said they believe there is complacency setting in while “key data points on bank balance sheets show that things have worsened on the margin since March.” We’ve been watching this relative to its potential impact on the commercial real estate loan refinances expected in the next 12-18 months.
Green Street said commercial deals are down a “stunning” 70% year over year.” With the U.S. vacancy average at 18 percent for office properties verses 3.8 percent for industrial properties, and given a lower per-square-foot cost relative to conversion to residential brokerage firm, a Newmark report find conversions from office to industrial are on the rise. Although delinquency rates for office properties are low, with office vacancy rates on the rise, the Financial Stability Oversight Council (FSOC) said Friday that they are stepping up scrutiny of how exposed banks are to commercial real estate.
Meanwhile, a slight decline in 30-year fixed rates over the past few weeks was met with a Mortgage Bankers Association (MBA) report that purchase applications increased “driven by a 2 percent gain in conventional purchase applications and a 3 percent increase in FHA purchase activity,” according to Joel Kan, MBA vice president and deputy chief economist. (The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($726,200 or less) decreased to 6.73 percent from 6.77 percent, MBA said)
The American Bankers Association’s Economic Advisory Committee said they expect credit conditions to tighten the rest of the year and loan losses to rise. Still, given the low inventory, the Census Bureau and HUD jointly reported this week that privately owned housing starts in May hit a seasonally adjusted annual rate of 1,631,000, 21.7% above the revised April estimate of 1,340,000 and up 5.7% year-over-year. The May rate for units in buildings with five units or more hit 624,000. Single-family housing starts were just shy of 1 million at 997,000, or 18.5% above the revised April figure — the largest single-month jump since June 2020 which occurred as the market rebounded from the initial shock of the COVID pandemic.
Both Warren Buffet and Jamie Dimon said in the days following the JPMorgan take-over of First Republic that the banking crisis is over, two pretty good sources on banking stress. It doesn’t mean there won’t be more bank failures—it seems inevitable there will be in the months ahead with the Fed tightening another quarter point last week putting several more under increased pressure. But it may mean from their vantage point banks with the interest rate exposure and those likely to feel the most pressure are small enough that consolidation is not going to cause contagion. It also means, however, that credit conditions will continue to tighten, slowing the economy. With the continued robust consumer activity and strong employment, however, that expected slowing appears slightly delayed and/or softened.
The banking credit tightening is certainly part of the story here because it may give the Fed room to stick with the plan to pause (in June) in order to observe whether recent rate moves are having the intended effect on inflation. The Federal Reserve survey of bank loan officers, out Monday, showed that credit conditions for U.S. business and households continued to tighten in the first months of this year.
In housing, the Mortgage Bankers Association (MBA) reported that mortgage credit availability fell in April to its lowest level since 2013, “matching the tightening in broader credit conditions stemming from recent banking sector challenges and an uncertain economic outlook,” Joel Kan, MBA Vice President and Deputy Chief Economist said.
MBA’s SVP and Chief Economist Mike Fratantoni perhaps summarized the current status well following the Fed statement last week: “We expect that the Fed will be ‘data dependent,’ and certainly would react to any renewed increase in inflation, but [the statement made by Chairman Powell] is consistent with a plan to pause rates at this level. Inflation is likely to trend down over the course of the year, particularly as weakness in the rental market begins to be reflected in the inflation numbers. In the near term, tighter credit conditions will slow the pace of economic activity. The housing sector is already operating under tight credit, so we don’t expect this headwind to outweigh the benefits from somewhat lower mortgage rates. The housing market is likely pulling the economy out of this slowdown, as it typically does.”
Activity at the Fed’s discount window and the Bank Term Lending Program rose in the past week, with banks borrowing $73 billion from the window and $82 billion from the program, up slightly and continuing to stay at high levels. With the seizure of First Republic Bank over the weekend and JPMorgan picking it up early Monday, pressure continues on banks that are similarly exposed to interest rate risk and risk of deposit flight. The Federal Home Loan Banks said advances rose 28% at the end of the first quarter from the close of 2022, reaching a record $1 trillion during the March banking crisis, slowing toward the end of the month.
Following the First Republic deal, shares of a few other banks — Comerica, PacWest Bancorp, Western Alliance Bank and Zions Bank — all sank in Tuesday trading. Eyes and ears will be on whether these potential failures cause dissenting votes Wednesday within the FOMC.
First Republic was the 14th largest bank at the end of 2022 and is now the second largest bank failure in history after Washington Mutual in 2008, which JPMorgan also acquired. Of note here is that JPMorgan will share a loss with the FDIC on loans, with the FDIC reportedly taking 80%. Commercial real estate loans were reportedly a relatively small portion (6%) of First Republic’s loan base. The residential mortgage loans are believed to be low interest, low LTV loans to good credit borrowers. Nearly 60 percent of First Republic’s loans were single-family mortgages, according to their most recent annual report.
The Wall Street Journal reports that home builders are enjoying stronger-than-expected business this spring, capitalizing on the recent fall in mortgage rates and the shortage of existing homes for sale. Active listings in March stood at roughly half of where they were four years earlier, according to realtor.com, in part because higher mortgage rates made many homeowners reluctant to sell and give up their current low rates, the Journal said. WSJ said newly built homes made up “about one-third of single-family homes for sale in March, according to data from the Commerce Department and the National Association of Realtors. The proportion of newly built homes reached nearly 35% in December, a record in data going back to mid-1982 and up from a historical norm of 10% to 20%.”
There continues to be a conundrum in US markets: Q1 was very strong for consumer spending, above pre-pandemic levels, substantially. There has been decent, though slowing, payroll data — the Bureau of Labor Statistics reported Friday that total non-farm payroll employment rose by 236,000 in March. It was the smallest increase in more than two years, but it was enough to push the unemployment rate down to 3.5 percent.
Still, there are real signs of wear and tear on the economy. A Black Knight analysis found more than 11% of borrowers who took out loans to buy houses last year had properties worth less than the debt on them in February. According to Inside Mortgage Finance, production of agency mortgage-backed securities fell to its lowest level in nine years in the first quarter of 2023.
We’ve discussed here the vulnerabilities of regional banks given exposure to the commercial sector, with retail hurting and office space values falling amidst higher rates and post-covid shifts in remote work. Regional banks with the weakest balance sheets and heretofore unrealized losses, even with the Fed facility lending at par, continue to give investors concern. Whether that is powerful enough to cause contagion is difficult to determine, but recent history makes it easy to see how another bank failure could re-ignite flows out of regionals with high levels of underwater loans and assets that have been propped up by lower rates (soon needing to be refinanced in a higher rate environment).
Corporate balance sheets are in better shape than they were prior to the global financial crisis which will help them weather earnings declines from underutilized office space, to a point, but we can expect defaults to rise and banks to continue to feel the pinch of lower interest margins and reduced income from lower loan volumes.