Mortgage Report Card

As the pace of economic growth went from strong in the first quarter last year to a more moderate level through the last nine months, the yield curve inverted during the second half of the year. The 1-year Constant Maturity Treasury, or the 1-year T-bill, ended the year at 4.99%, or 70 basis points higher than at yearend 2005, while the 10-year Treasury note ended at 4.63%, only 14 BPS higher from that same period.

The 30-year fixed-rate mortgage average jumped 55 BPS from 2005 to 6.42%, and the 1-year adjustable-rate mortgage average soared more than a full percentage point to 5.54%.

The higher rates contributed to cooling housing markets after a series of boom years in many parts of the country. As home sales declined significantly, although remained high by historical standards, house price appreciation slowed dramatically.

About 64 percent of home sales were for primary residence purposes, nearly 22 percent were investment properties and the remainder vacation homes, with primary residences increasing 4 percent from the previous year or the combined percentage the latter two housing purpose shares fell.

The purchase-price house price index estimated that prices grew just 4.3 percent between the last quarter of 2005 and the fourth quarter 2006 — which is less than half the 10.7 rate for the previous year. The slowdown in 2006 represented the sharpest deceleration in the period covered by OFHEO’s house price index, which extends back to 1975, and was also notable “because, unlike previous slowdowns, this deceleration was not caused by marked deterioration in household incomes or employment.”

The Mountain region held the greatest rate of appreciation at 9.2%, while the New England region held the slowest at -0.4%. Some of the most dramatic deceleration occurred in areas that had exhibited the highest appreciation during the boom period, such as Florida, California, and Nevada, which all had prices fall between the third and fourth quarters.

Higher interest rates and a slower pace of home sales reduced mortgage originations last year.

Single-family mortgage originations declined 4.5 percent from 2005 to $2.98 trillion, or the third highest volume ever, “driven by relatively low interest rates and record volumes of lending to borrowers that took out low-documentation loans and home equity lending.” Alt-A lending increased 5.3 percent to $400 billion and HE lending jumped nearly 18 percent to $430 billion. Conforming loan originations were off 9 percent at $990 billion. Government-insured originations continued falling and at $80 billion was the lowest level in years. Prime jumbo volume sunk nearly 16 percent to $480 billion.

Subprime loans increased slightly to account for 20.1 percent of total single-family originations. The Alt-A share was 13.4 percent of total volume, whereas HE volume made up 14.4 percent. In late fall, subprime originations began to experience significant contraction through the fallout of many top subprime lenders, as well as more regulatory scrutiny, decelerating house appreciation, and diminished investor appetite for subprime loans. These factors led lenders to begin tightening underwriting standards significantly for nonprime mortgages after early defaults of 2005 and 2006 originations began to place financial stress on subprime originators.

As the Treasury yield curve inverted, ARM originations, at $1.34 trillion, represented almost 45 percent of all single-family loans, decreasing from nearly 48 percent in 2005.

The top 25 lenders originated 87 percent of single-family mortgages, up from the previous year’s level of 83 percent. In 1994, the top lenders originated only one-third. The retail channel continued to have the largest share at 38 percent, although this is down from levels in 2003 and 2004, the correspondent share at nearly 33 percent topped the broker share — which fell to 29 percent from 31 percent in 2005 — for the first time in three years.

The decline in originations reduced the volume of residential mortgage-backed securities issued by 5 percent to $2.1 trillion. The combined share of Fannie Mae and Freddie Mac single- and multi-class MBS issuance fell slightly to below 41 percent .Private-label MBS issuance dropped 4 percent from a record high in 2005 and for the first since 2000 to $1.1 trillion last year but its share still edged up to 50 percent. Ginnie Mae’s share rose to 4.0% after having declined for five years in a row.

The share of private-label MBS backed by Alt-A mortgages increased during the year to 32 percent. Meanwhile, the share backed by prime loans, mostly jumbos, dropped 4 percent to 19 percent and for subprime fell by the same percentage to 39 percent, while Ginnie declined slightly to $83 billion.

After two years of rapid growth in 2004 and 2005, the private-label share of GSE and private-label MBS held by all investors, including the enterprises, rose very little in 2006. The private-label share edged up 1 percent to 32 percent and the enterprise share of MBS held by all investors fell slightly to 61 percent at yearend.

Freddie and Fannie mortgage purchases, which include cash purchases from lenders and swaps of whole loans for MBS, totaled $909 billion, down 4 percent. Fannie’s volume of $545 billion decreased 2 percent, while Freddie’s $364 billion decreased 7 percent. Purchases of single family mortgages fell 5 percent to $876 billion, with Freddie’s $351 billion being off 8 percent and Fannie’s $524 billion being down 2 percent from a year earlier — the lowest single-family purchase volumes by the GSEs since 2000.

Residential mortgage debt outstanding grew nearly 9 percent to $10.9 trillion in 2006, breaking a five-year string of double-digit growth. At yearend, the combined books of business of Freddie and Fannie represented about 39.3 percent of the total residential mortgage debt outstanding, down slightly from 39.9 percent in 2005.

While the government-sponsored enterprises continued to be active in the subprime, A-, and Alt-A mortgages and MBS backed by those loans, they shifted away from subprime toward Alt-A and A- mortgages last year. Together they purchased $90 billion in private-label MBS backed by subprime mortgages in 2006, which represented 20 percent of those securities issued, down from $169 billion or 33 percent a year earlier. Freddie’s share of Alt-A and A- MBS purchases went up to $68 billion from $50 billion, and Fannie’s share of low doc MBS purchases shot up to $113 billion from $56 billion.

Both increased their share of interest-only mortgages, with Fannie’s growing to 15 percent of all its single-family acquisitions from 10 percent a year prior and Freddie’s increasing to 16 percent from 6 percent. But their purchases of nontraditional mortgages, other than IO, decreased. For example, non-IO hybrid mortgage purchases decreased to 5 percent from 9 percent of the GSEs single-family purchases and option ARMs declined to 2 percent for Freddie while remaining at 3 percent for Fannie.

Fannie’s share of ARM single-family purchases fell to below 18 percent from 22 percent and the reverse was true for Freddie.

The performance of GSE single-family mortgages improved in 2006, but recent purchase trends may lead to weaker future performance. While delinquency rates remain relatively low after rising in late 2005 after hurricane activity, their “increased investment in ARMs and non-traditional mortgages may expose them to higher levels of credit losses in the future.”

Nonetheless, interest rate risks were reasonably well contained in 2006.

And estimated enterprise credit losses from house price shock remains low, OFHEO said. The credit loess each GSE incurs on its single-family credit book of business are sensitive to the prices of single-family homes. Freddie’s net credit loss sensitivity at yearend, $770 million, represented about 2.1 percent of its core capital as of year-end and about 0.04 percent of its conventional single-family mortgage credit book of business, while Fannie’s net sensitivity of $1.4 billion, represented about 3.3 percent of its core capital and about 0.07 percent of the book.

Furthermore, both GSEs continued working on their accounting issues and internal control problems last year and some progress was made. Fannie’s restated financials for the three years ending 2004 showed a decrease in retained earnings of $6.3 billion and the company has yet to release 2006 financials.

Both enterprises were classified as adequately capitalized throughout 2006. And based on current Fannie has achieved a reasonable level of profitability in 2006, although earnings continued to be reduced by declining net interest income. Meanwhile, Freddie’s reported net income increased to $2.2 billion last year after declining for three years in a row.