Pricing, Commercial Loan Products; a Primer for Lenders on Treasury Auctions; Weather Damage Mounts

“What do they call the 4th of July in nursing homes? In Depends Day.” (Another joke at the bottom.) There are plenty of elderly people, year ‘round, and hurricanes, seasonally, in Florida. There are ways to build homes that will survive hurricanes. Wood is not the solution! Here’s a story about Florida resident Amy Hawk who was paid only $8,000 by her insurance company after a hurricane destroyed her house and what she’s doing about it. Damages from weather disasters hit $92.9 billion last year, according to NOAA, and years of increasingly damaging weather events have provoked a reaction in the insurance market, with costs up 13 percent from 2020 to 2023. Those are being driven by premium increases in some of the areas most prone to disasters, and a big driver in turn is the rising cost of reinsurance, which is the insurance bought by insurance companies which itself has increased in costs 100 percent between 2017 and 2023. Home insurance companies are roughing it: for the fifth year in a row, insurers paid out more than they brought in with premiums, and in 2023 they paid out $1.11 in claims for every $1 they made. (Today’s podcast can be found here and this week’s is sponsored by The BIG Point of Sale, which offers a highly configurable, easy to install point of sale solution. Its simplified consumer workflows and web-based portals allow for consumers and loan originators to collaborate with the back-office team to keep everyone informed throughout the loan process. Hear an interview with Nectar’s Derrick Barker on the Federal Housing Finance Agency announcing higher caps that allow Fannie and Freddie to purchase up to $146 billion in multifamily loans.)

Software, Products, and Services for Lenders

Commercial Lending is experiencing hyper growth due to $1.5 trillion in ballooning loans over the next 3-5 years. There is a shortage of commercial mortgage brokers, and with banks liquidity issues, a perfect storm is brewing for the secondary market that will create massive deal flow. Chris Perez, Oceanview Commercial Lending, a 25-year veteran, is offering a private, by invite only, broker partnership program. This is a turnkey opportunity with training, unique tool set, marketing, and even Live leads daily. He is looking for 10 brokers per state to add a commercial mortgage channel while continuing to do your normal residential business. Schedule an appointment today to see if you qualify. Adding commercial to your book of business is a way to expand your current product line while substantially increasing revenue.

An open letter from Polly Founder and CEO, Adam Carmel: “As we near the end of another incredible year, I am reflecting on Polly’s mission, our vision, and what we have been able to achieve in collaboration with our customer partners. When Polly was founded in 2019, it was clear then—and even more so now—that legacy pricing technology was doing the mortgage industry a disservice. The average cost to originate a loan has increased over 500% in the last 20+ years, and yet, the mortgage industry was burdened by the same antiquated capital markets software. I thought to myself…” Read more!

Primer on Treasury Auctions

There are many different ways to sell things: a lemonade stand, a flea market, through Target, or at an auction, to name but a few. Lenders sell their loans through a variety of ways, and they tend to go to the highest bidder who offers minimal hurdles. U.S. Treasury auctions aren’t all that different from any other public or private auction, but selling newly issued Treasury bill, note, or bond typically involves billions of dollars and can move world markets. Securities are purchased at a certain price, which determines the yield, which helps determine the rates of other securities… like securities backed by mortgages.

To take a step back, many companies issue stock or offer debt to investors. The United States, however, has used only debt to help pay for the services it provides since the country was founded. The government still offers a range of securities nearly weekly, such as Treasury bonds, notes, and bills, also known as T-bonds, T-notes, and T-bills. They vary by factors like the duration of the contract, the size of the offering, and the amount of interest they pay. That last part is important because it determines the return, or yield, an investor gets every year.

Each quarter, the U.S. Treasury department releases refunding announcements estimating how much debt will be auctioned in the next two quarters and how that debt will be split into various maturities. Everyday investors, institutional investors (such as banks), and central banks of foreign countries typically buy them, as anyone can bid for Treasuries through a TreasuryDirect account or through a bank, broker, or dealer.

Just as investors in MBS watch application data and security issuance, Treasury investors watch the supply. If the Treasury forecasts it needs to issue more debt than expected, it can cause yields to climb as prices drop so that it can all be sold. The Treasury holds nearly 300 auctions each year and sells more than $8.3 trillion worth of securities. Interest rates are set based on the auction results, which affects the prices people, banks, and brokers pay the Treasury for the security. These yields, based on supply and demand, help determine mortgage rates.

Mortgages rates follow T-note and T-bonds, not bank rates. Remember that the Federal Reserve controls the rates at which banks loan money to each other overnight, known as the fed funds rate. But mortgages have a much longer lifespan, and as a result they most closely track 5-year or 10-year U.S. Treasury notes, debt issued by the U.S. government and traded by investors in the bond market. And the prices of those are based on investor expectations.

If investors expect inflation to be higher, for example, investors will want higher yields so their investments don’t lose value. It’s also the case that when inflation goes higher, the risk that interest-paying investments will lose value makes their prices decline. Bond prices decline when yields rise, and vice versa.

We are asked, “Why are mortgage rates higher than bond yields?” While mortgages go in the same direction as the bond market, there is still a big “spread,” or difference between the two. Currently 30-year fixed-rate mortgages are 6.75-7.25, whereas the yield on the 10-year risk free Treasury note is around 4.60.

Mortgages are much riskier investments than debt issued by the government of the largest economy in the world. Individual homeowners can and do default regularly. Mortgages are also riskier because homeowners have the ability to refinance whenever they want, for any reason, with no penalty. Investors and institutions that buy mortgages and mortgage bonds have no guarantee that they’ll be able to count on constant cash flows from those financial products, so they demand more yield (and lower prices) to buy them.

But mortgage rates aren’t even staying the same. They’re rising. In short, that’s because inflation is still an issue, the economy is doing well, and risks are rising. The monthly cash flow of borrowers has worsened with many seeing higher insurance costs. The U.S. Fed has made significant progress in taming runaway inflation, but finally touching its 2% target will be hard. Policymakers acknowledged as much a few weeks ago when they forecast fewer rate cuts in 2025 than previously expected. “Inflation has been moving sideways,” Fed Chair Jerome Powell said at a news conference, adding that achieving the goal of 2% inflation has “kind of fallen apart as we approach the end of the year.”

There’s little reason to expect the bond market to pick up, e.g., prices to go up, and rates go down. There is concern about the debt and the deficit, but also, we are in an environment where economic growth is looking like it’s going to remain stronger. And that requires a higher natural rate of natural interest rates.

Mortgages, meanwhile, have their own concerns: with rates for home loans having been so elevated for such an extended period over the past two years, investors have every reason to expect more prepayment risk than usual. No one wants an 8 percent mortgage if they can refi and obtain 6.75. (On top of this, insurance and property tax bills are now greater than mortgage payments for many homeowners. But that is a story for another day.)

Capital Markets

Last week was slow with most people away from their desks. But the bond market closed with the 10-year Treasury yield hitting a 7-month high of 4.62 percent and the 2s10s spread widening to 29-basis points from 25-basis points. Despite a sharp sell-off in stocks on Friday, Treasuries didn’t see significant flight-to-safety demand, as higher yields were blamed for the weakness in the stock market.

Yields across the curve have shifted higher over December, reflecting a shift away from expectations of rate cuts, especially after December’s hawkish FOMC meeting and the anticipated Fed pause on cuts throughout 2025. Investors are also adjusting their outlook on fiscal policies under President-elect Trump, including expected tax cuts and tariffs in 2025. Economic data showed a widening trade deficit to $102.9 billion in November, with retail inventories up 0.3 percent and wholesale inventories down 0.2 percent. The market is closely watching for further policy and economic developments.

On this last full trading day for 2024, there are a few items of interest beginning later this morning with Chicago PMI for December, followed by the pending home sales index for November and Dallas Fed manufacturing for December. Looking over the remainder of the week, house price indexes for October precede the SIFMA recommended 2pm ET close tomorrow, markets are closed on Wednesday for New Year’s, while the first trading day of 2025 will get the last of the week’s data consisting of jobless claims, ISM manufacturing for December, and construction spending for November. Additionally, on Thursday the Treasury will announce details of next week’s mini-Refunding. We begin the chopped-up week with Agency MBS prices slightly improved from Friday’s close, the 2-year yielding 4.29, and the 10-year yielding 4.59 after closing last week at 4.62 percent.