Monday, April 29, 2013

Refi Reality: How to Benefit from the End of the US Refinancing Wave


The Tradex Group Weekly Blog
April 29, 2013
By Richard Travia, Director of Research

Refi Reality:  How to Benefit from the End of the US Refinancing Wave

If there is one indisputable catalyst that has helped the U.S. economy since 2008, it is cheap money – and lots of it.  Ultra-low interest rates, unprecedented monetary easing and never before seen government implemented programs have kept yields on long-dated fixed income artificially low, making borrowing money as cheap as it’s ever been.

It’s clear that the efforts have paid off – the U.S. economy has been slowly gaining traction and consumer spending, one of the main engines of growth, has been steadily ticking up.  Equally important, the Federal Reserve’s quantitative easing efforts have helped spur mortgage refinancing activity, driving down home loan rates and encouraging borrowers to refinance their mortgages.

The refinancing boom has certainly been impressive.  Despite slow to recover home prices in many parts of the country and difficulties among consumers in obtaining additional credit, mortgage refinancing has been the vast majority of overall mortgage activity since 2009, according to the Mortgage Bankers Association.

Indeed, refinancing activity over the past three years has saved borrowers $46 billion in interest payments, according to Moody's Analytics – money that consumers have used to purchase goods and services that in turn have helped propel the economy.

What it has also propelled is prepayment activity.  Consumers have been able to refinance their interest rate from 6%+ to approximately 4%, in many cases regardless of the equity they own in their homes.  This has naturally reduced the interest portion of a homeowner’s monthly mortgage payment.  Government programs such as HARP (and HARP 2.0) have accelerated this trend by getting underwater borrowers lower mortgage rates. 

But cracks are starting to appear.

While volatile, both mortgage activity and refinancing activity have slowed in recent months, with refinancing activity dropping to its lowest share of total activity in 10 months in March.  Indeed, refinancing accounted for 75% of all mortgage applications, down from 85-90% only a few weeks earlier and the smallest share of total applications since May 2012.

What it all points to is the inevitable end of the greatest refinancing boom ever.  Whether because rates can’t or won’t go any lower or because the majority of U.S. homeowners have already moved to refinance and lock in new mortgages at lower rates, activity appears to be waning.
  
While higher interest rates may be bad news for new homeowners and potentially the broader economy, it’s good news for holders of IO mortgage derivatives contracts.  As the speed of prepayments (refinancing) decelerates, a larger amount of interest payments will flow through to the IO security, creating larger monthly cash-flows and eventually resulting in a rise in IO prices.  The number of homeowners who pay down their mortgages via a refinancing – and in turn do not generate any more interest payments on their original mortgage – will inevitably slow.

And, as the saying goes, what goes down must go up, meaning sooner or later bond yields, and by extension, mortgage rates will begin climbing again, further reducing the virtuous circle of refinancings and pre-payments.

The conclusion:  Being invested in IO derivatives, and getting paid while you wait for higher interest rates, is a great place to be.  At Tradex, we have seen extraordinary results over the years from IO mortgage derivatives and are ready to increase our allocation again.  Given that rates can’t go much lower and inevitably will go higher, we are patiently waiting for IO’s to appreciate both quickly and substantially.

Thursday, April 25, 2013

MBA Mortgage Applications 4-24-13


MBA Mortgage Applications 4-24-13

TRADEX GLOBAL INTERNAL COMMENTARY

US mortgage applications were up 1% in the latest week. The Re-finance index was up slightly, 0.3% from the prior week.  The purchasing  index (new mortgages) was at its highest level since May 2010.  The share of applications to refinance an existing mortgage stayed unchanged at 75% and the share of HARP increased 1% to 32%, the highest level since MBA has tracked HARP.  Mortgage rates were a touch lower with conforming rates at 3.65% from 3.67% the prior week.  Our take here is the same as the last few months: the percentage of applications to refinance has been averaging 75% from a high of 90%, which clearly shows new mortgages are starting to gain momentum.  We still see re-fi’s at elevated levels and HARP programs are still working to get consumers lower mortgage rates.  It is also showing that the speeds of re-fi’s are slowing as guarantee fees are rising and a good amount of borrowers have already refinanced in the “interest rate sensitive” pools.  We are convinced, and the MBA data agrees, that we are close to the end of the greatest re-fi wave in history and that our IO’s will appreciate greatly, and while we wait we still get a very decent hedged return.  Stay tuned, we are very excited about our portfolio.  Keep nimble – Michael Beattie

EXTERNAL RESEARCH COMMENTARY

The total number of mortgage applications filed in the U.S. last week rose 1% from the prior week as several mortgage rates crept lower, the Mortgage Bankers Association said Wednesday. The market composite index increased 0.2% on a seasonally adjusted basis for the week ended April 19 from the prior week, according to MBA's weekly survey, which covers more than three-quarters of all U.S. residential-mortgage applications. The refinance index edged up 0.3%. On a seasonally adjusted basis, the purchasing index was up 0.3% from the prior week, marking its highest level since May 2010. Low interest rates have attracted new buyers and persuaded many homeowners to refinance their mortgages. However, tightened credit restrictions still bar many borrowers from filing loan applications. The share of applications filed to refinance an existing mortgage was unchanged from the prior week at 75%. Adjustable-rate mortgages, or ARMs, decreased to 4% of total activity from 5% a week earlier. The Home Affordable Refinance Program share of refinance applications increased to 32% from 31% a week earlier, the highest level since MBA began tracking HARP applications in February 2012. The average rate on 30-year fixed-rate mortgages with conforming loan balances slipped to 3.65% from 3.67% in the prior week. Rates on similar mortgages with jumbo-loan balances edged down to 3.75% from the previous week's 3.77%. The average rate on 30-year fixed-rate mortgages backed by the Federal Housing Administration was unchanged from the prior week's 3.37%. The average rate for 15-year fixed-rate mortgages decreased to 2.89% from 2.91% a week earlier. The 5/1 ARM average rate, meanwhile, rose to 2.62% from 2.57% a week earlier.


Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500
@Tradex_Global

Wednesday, April 24, 2013

Take 20: Why Putting 20% in Alternatives Makes Absolute Sense


The Tradex Group Weekly Blog
April 24, 2013
By Richard Travia, Director of Research

Take 20:  Why Putting 20% in Alternatives Makes Absolute Sense

If there were three words post-2008 every investor should have written out on a post-it note, they were diversification, diversification and diversification. The lesson clearly learned is that spreading your eggs around is a lot more prudent than putting them in one or two baskets.

Yet more than four years following the global credit crisis and financial market rout, the predominant majority of individual investors still allocate their portfolios to traditional investments: stocks, bonds and other variations that incorporate no other strategies than buying equities and bonds in some form – typically in a 60/40 ratio or some variation of it.

The reason:  the vast majority of investors still aren’t even aware of, let alone educated on alternative investments such as hedge funds, private equity funds and managed futures funds that invest in less-traditional asset classes...Or if they are, they don’t have access to them.  Historically, the hedge fund asset class has been dominated by institutional investors. 

That's about to change, thanks to the Jumpstart Our Business Startups, or JOBS Act, which President Barack Obama signed into law in April 2012.  Once the U.S. Securities and Exchange Commission finishes re-writing the rules on advertising and soliciting, the Act will, for the first time, allow hedge funds and other alternative investment managers to advertise who they are, what they do and why they can be a healthy part of an investor's portfolio.

For years, hedge funds were strictly prohibited from marketing their products and soliciting new business. The at-best fuzzy rules dictated that only an individual who had passed the test of qualifying as an accredited investor – one with a minimum net worth of $1 million, not including the value of their primary residence – could speak to an alternative investment manager about their private offerings.  Even then the manager or anyone involved with the operation could not be viewed as soliciting the investor. 

Although the qualification rules still remain, The JOBS Act is a game changer.  While the much broader piece of legislation is aimed at giving breaks to small businesses, part of the Act makes for new allowances that permit hedge funds to market themselves – and their past returns – to a wider audience.  Just as Fidelity can advertise in a newspaper or on a highway billboard, so too will hedge funds be able to do the same.

 What this holds for accredited investors is the promise of additional transparency and a clear choice in true portfolio diversification, a must-have in the post-2008 world.  What it means for advisors and others who help steer money for clients is a duty to ensure that their clients are aware of – and diversified in – alternative investments – with at least 20% of a portfolio asset allocation.  Dean Catino of The Smarter Investor wrote in December 2012 that “By combining traditional asset classes with alternative investment options, like managed futures, commodities and others, as well as strategies centered on risk management and tactical management, there is a potential to increase returns and lower volatility.  It’s the sort of thing that university endowments do now, with some success.  As reported by the NACUBO-Commonfund Study of Endowment Results, over the last decade, the Standard & Poor’s 500 index returned a modest 2.7 percent, while 472 university endowments of all sizes consistently outperformed the index.  Interestingly, endowments with the greatest exposure to alternative assets performed the best, with average annual yields of 6.9 percent.”
As most investors now know, diversification is key to ensuring a healthy portfolio that can withstand shocks and volatility.  The key will be figuring out how best to diversify to ensure when the next negative surprise hits that the broader portfolio is protected.