StartBank Predicts Mortgage Rates May Reach 5% in 2003
NEW YORK--(BUSINESS WIRE)--Oct. 16, 2002--
Press Release: "...2002 will be a record year with home sales of
6.5 million units. If low interest rates continue as we expect them
to, 2003 could be an even better year for home sales....We are
anticipating $2.2 trillion (in originations) for 2002,...and 2003
will be just as strong." - Freddie Mac
Summary
Mortgage rates are influenced by long-term rates, which are influenced by three factors: (1) Short-term rates - economic weakness suggests the Fed is likely to reduce rates, (2) Inflation - inflationary expectations are near forty-year lows and (3) the Overall Economy - the DJIA and the S&P 500 are near their lowest levels since 1997 marking the worst bear market since the 1930s. Although today's mortgage rates are attractive in absolute terms, they remain high relative to the broader credit markets. The spread between the Fed Funds Rate and 30-Year Mortgage Rates is at a 10-year high, suggesting mortgage rates will continue to fall, potentially below 5%.
Introduction
As mortgage rates continue to trend downward, many investors are focusing--not upon how low mortgage rates will ultimately go--but rather, upon when the trend will reverse itself. This pessimistic thinking is unwise. Adding to the problem, mortgage market bears have been especially outspoken, suggesting that long-term rates are sure to rise, thereby spelling trouble for mortgage lenders. This hypothesis is unfounded. Long-term interest rates influence residential mortgage rates directly, and are themselves influenced by: (1) the Federal Reserve's manipulation of short-term rates, (2) inflationary expectations, and (3) the strength of the overall economy. Taken one by one, analysis of each of these market forces reveals that mortgage rates actually have further room to fall, and are likely to fall throughout 2003.
Fed Watching
The Federal Reserve has incrementally lowered short-term rates 449 basis points since 2000, from 6.24% to 1.75%. Third quarter economic indicators remain mixed, suggesting continued weakness in the US economy, and reducing the likelihood of a significant turnaround until 2004. As a result, the Fed is no more likely to raise short-term rates next year than it was this year. In fact, based on recent Treasury market activity, the likelihood of the Fed easing short-term rates by November is increasing. On September 24, 2002, yields on US Treasuries reached their forty-year lows. Moreover, Fed Funds futures contracts, viewed as an indication of future interest rate moves, suggested an 18% chance of the Fed reducing its target rate again in October, thereby preempting the next scheduled FOMC meeting in November. Not only will the Fed not increase short-term rates in November, it may actually reduce them before then.
Inflation
As the US economy of the early 1980's revealed, inflation can wreak havoc on financial markets and general economic prosperity. Moreover, inflationary expectations can erode bond prices profoundly, thereby sending yields soaring. As a result, defending against inflation has become the battle cry of the Federal Reserve through the last five presidential administrations. On this front, the Fed has won both the battle and the war. Today, 8 of the 16 components of the consumer price index have turned negative, representing the highest percentage of declining sub-sectors since 1955. In addition, the personal consumption deflator, Fed Chairman Alan Greenspan's inflation gauge of choice, has averaged a mere 1.75% for the past five years. In short, both inflationary expectations and US Treasury yields are at or near forty-year lows, and likely to remain there.
The Overall Economy
The US economy has been in recession since the third quarter of 2000. Plagued by the bursting stock market bubble, mounting unemployment across many sectors, widespread corporate scandals and the profound impact of the September 11 terrorist attacks, the US economy keeps resisting the opportunity to gain momentum. As a result, the Fed's second-highest priority of fostering economic growth has been slowly gaining ground as Mr. Greenspan declares victory in the war on inflation. This will likely result in further reductions in key short-term interest rates. But at the very least, the Fed will not raise rates anytime into the foreseeable future.
Even Lower Mortgage Rates
During the 1990's, the Fed reduced the federal funds rate by a total of 313 basis points. Thirty-year mortgage rates declined by 256 basis points during the same period, representing an average spread over the federal funds rate of 317 basis points. As indicated earlier, the Fed has reduced its target federal funds rate by 449 basis points in the last three years. Residential mortgage rates, however, have not yet fallen proportionately. Mortgage rates have fallen from 8.21% in 2000 to 6.26% today, a decline of 195 basis points, representing a current spread to the federal funds rate of 452 basis points. The following graph illustrates the spread between the Fed Funds rate, the 10-year US Treasury and 30-year mortgage rates from 1995 through 2006 (projected).
The spread today between mortgage rates and the Fed Funds rate is currently 42% higher than it was during the 1990's, and 85% higher than it was from 1995 through 1999. Therefore, as compared to the broader credit markets, today's residential mortgage rates are extremely high. Given the historical relationship of mortgage rates to the Fed Funds rate, a 30-year mortgage rate near 5% is likely to occur in 2003.
More Good News For Mortgage Bankers
The potential benefits to mortgage bankers resulting from further reductions in mortgage rates are compelling. Driven by falling rates, and supported further by increased efficiency in the application and approval process, US homeowners have demonstrated an inclination to continually refinance higher rate loans as mortgage rates trend downward. In 2001 alone, more than $2 trillion in home loans were processed. Moreover, Freddie Mac is forecasting an additional $2.2 trillion in volume for 2002. On average, refinancings have accounted for more than 40% of this record volume. Many homeowners have actually refinanced twice, and even three times, over the past 12 to 18 months. Indeed, relative interest rates influence today's homeowner, not absolute values.
Refinance Boom
Today's homeowner will continually refinance out of relatively high rates as mortgage rates trend lower. Therefore, of the $2 trillion of loan originations completed in 2001 at an average rate of 7.16%, nearly all of them will be "eligible", by today's standards, for refinancing as rates approach 6.0%. Additionally, the $2.2 trillion in loans originated in the 6.5% range during 2002, will be ripe for refinancing as rates approach 5% during 2003. Similarly, with still lower mortgage rates on the horizon, today's ongoing wave of refinancing loans may themselves be ripe for refinancing in the very near future. Overall, contrary to popular, yet uninformed opinion, the prospect of more than $4.2 trillion of recently closed mortgage loans being refinanced within the next 18 months is entirely possible and more likely probable.
Investment Opportunity
Mortgage lenders have enjoyed a remarkable run of earnings growth over the past several years. Given the strength of the short-term credit markets, as seen in the historically low federal funds rate, many would-be buyers of mortgage banks have elected to focus on when the trend will reverse itself, rather than on how low mortgage rates can actually go. Although today's mortgage rates are attractive in absolute terms, they remain high relative to the broader credit markets, most notably, the federal funds rate. Thirty-year mortgage rates actually have considerable room for further decline, suggesting that the likelihood of a dramatic reversal of fortune among well-managed mortgage banks over the coming years is remote. In fact, today's buyers of mortgage banks could actually recoup their entire purchase price within the next 12 to 18 months as mortgage companies post record earnings. The bottom line: Buy Mortgage Banks Now!!!
StartBank Advisory Services
StartBank is an investment banking firm specializing in the mergers and acquisitions of mortgage companies. We are experts in the field of mortgage banking and investment banking: Richard Easton, CEO has 25 years mortgage experience, Brian Simon, COO has 11 years mortgage experience, and Nicholas Rizzetta, CFO has 30 years mortgage experience. StartBank has been executing the mergers and acquisitions of mortgage companies since 1999. As the Dow Jones said in a recent Newswire, "Look no further than StartBank."
StartBank Analysis: Richard Easton, Chairman & CEO
David Bonomo, Managing Director
Devin Kalman, Senior Analyst
Note: A Graph is available at URL:
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