Quantitative Easing & the Housing Market

American Enterprise Institute

April 9, 2013
CARRINGTON INVESTMENT SERVICES 599 PUTNAM AVENUE GREENWICH, CT 06830

Carrington Investment Services is a SEC registered broker-dealer, member of FINRA and SIPC

Quantitative Easing & Housing

QE is a radical Fed policy intended to reflate asset, job markets

Fed funds target has been set at 0.25% since 2008 FOMC is purchasing $40 billion per month of agency securities and $45 b/m of Treasury paper, reinvesting principal payments into RMBS FOMC (3/13): these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative FOMC believes that QE will help to revive job market and boost activity in housing, consumer sectors, indirectly create jobs

QE is effectively a massive tax; a wealth transfer from individual and corporate savers to debtors, constraining spending by former
QE also represents significant reduction/manipulation of the duration of financial assets, creating future credit, liquidity risk to banks, individual investors when QE policy ends

April 9, 2013

Net Interest Margin All US Banks ($M)

QE has lowered bank funding cost by $80 billion per quarter
Total interest income Total interest expense Net interest income

200,000
180,000

160,000
140,000

120,000
100,000 80,000 60,000 40,000 20,000 0

Source: FDIC Quarterly Banking Profile (12/31/2012)

April 9, 2013

2013 Housing Market Outlook

Key housing metrics are pointing in the right direction

Home prices are appreciating steadily

January 2013 up 8.1% YOY, best in six years Consensus forecast is for 3-4% increase in 2013

For first time since 2006, no quarterly winter price decline

Existing home sales are up

Anticipated sales of 4.9-5.0mm units

New home sales are up dramatically

Anticipated sales of 400-450,000

Housing starts are at multi-year highs

Home builders are running 2-3x 2011 run rates

Delinquency and foreclosure rates are down

Bank charge-offs at 1% of total loans down from over 2.5% in 2009

April 9, 2013

Case-Shiller 10/20 City Index

4
100.00 200.00 250.00

150.00

50.00

0.00 January 1987 October 1987 July 1988 April 1989 January 1990 October 1990 July 1991 April 1992 January 1993 October 1993 July 1994 April 1995 January 1996 Composite-10 CSXR-SA Source: Standard & Poor's (3/31/2013) Composite-20 SPCS20R-SA

October 1996
July 1997 April 1998 January 1999 October 1999 July 2000 April 2001 January 2002 October 2002 July 2003 April 2004 January 2005 October 2005

July 2006
April 2007 January 2008 October 2008 July 2009 April 2010 January 2011 October 2011 July 2012
April 9, 2013

2013 Housing Market Outlook

But its a slow, atypical recovery in housing prices

Economic growth is weak

Unemployment rates are stubbornly high, creating 150-200k jobs monthly

Existing home sales will be 2mm off peak levels in 2013

Household formation will grow, but homeownership rates will decline

Home prices have recovered - but only to 2003 levels

Low inventory levels and investor interest price drivers

Mix of properties sold (fewer REOs) contributing to price hikes

Mortgage origination is expected to decline this year & next

Credit remains tight and QM rules will likely make it tighter

Total 1-4 lending down $200-300 billion in 2013 to $1.4 trillion

Very little non-agency mortgage lending Bank refinance boom probably peaked end of 2012

April 9, 2013

Banks Not Supporting Housing Sector

No net bank credit growth under home price recovery

Fed QE policy dramatically reduced cost of funds for

banking sector, but this is not translating into growth in bank credit for 1-4 family home purchases

Tougher credit criteria, increased regulatory hurdles

largely offsetting cheaper bank funding costs. Banks focused on writing prime loans for FHA, agency market

Flat to down lending by banks, plus reduced servicing,

agency balances, adding to tight credit markets for many borrowers. Agency loan guarantee fees have doubled and will go higher over next several years
April 9, 2013

Loans for Real Estate, All Banks ($M)

Bank portfolio of residential real estate loans flat to down
5,000,000 4,500,000
Loans secured by real estate 1-4 Family residential mortgages 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 0

Nonfarm nonresidential
Construction and development Home equity lines Multifamily residential real estate

Source: FDIC Quarterly Banking Profile (12/31/2012)

April 9, 2013

Unused Credit Lines, All Banks ($M)

Exposure at default for residential, commercial real estate flat

Source: FDIC Quarterly Banking Profile (12/31/2012)

April 9, 2013

Exposure at Default: Top 50 Banks (%)

300

Citi Peer Avg

250

JPM

200

150

100

50

Source: FDIC RIS/The IRA Bank Monitor (12/31/2012)

April 9, 2013

Gross Defaults: Top 50 Banks (bp)

10
100 200 300 500 600

400

0
Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07

JPM

Source: FDIC RIS/The IRA Bank Monitor (12/31/2012)

Peer Avg

Mar-08
Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11

Mar-12
April 9, 2013

Sep-12

Non-Performing Loans, All Banks: ($M)

11
30-89 days past due 90 days or more past due In nonaccrual status Source: FDIC Quarterly Banking Profile (12/31/2012) 1986:Q3 1987:Q2 1988:Q1 1988:Q4 1989:Q3 1990:Q2 1991:Q1 1991:Q4 1992:Q3 1993:Q2 1994:Q1 1994:Q4 1995:Q3 1996:Q2 1997:Q1 1997:Q4 1998:Q3 1999:Q2 2000:Q1 2000:Q4 2001:Q3 2002:Q2 2003:Q1 2003:Q4 2004:Q3 2005:Q2 2006:Q1 2006:Q4 2007:Q3 2008:Q2 2009:Q1 2009:Q4 2010:Q3 2011:Q2 2012:Q1 2012:Q4 0
April 9, 2013

20,000

40,000

60,000

80,000

100,000

120,000

Estimated Originations: 1990-2014 ($B)

Mortgage originations for refinance and purchase are falling

900 800 700

Mortgage Originations: 1-4 Family: Purchase (Bil.$) Mortgage Originations: 1-4 Family: Refinance (Bil.$)

600
500 400 300 200

100
0 2000 - Q1 2000 - Q3 2001 - Q1 2001 - Q3 2002 - Q1 2002 - Q3 2003 - Q1 2003 - Q3 2004 - Q1 2004 - Q3 2005 - Q1 2005 - Q3 2006 - Q1 2006 - Q3 2007 - Q1 2007 - Q3 2008 - Q1 2008 - Q3 2009 - Q1 2009 - Q3 2010 - Q1 2010 - Q3 2011 - Q1 2011 - Q3 2012 - Q3 2013 - Q1 2013 - Q3 2014 - Q1 2012 - Q1 2014 - Q3

Source: Mortgage Bankers Association (3/31/2013)

April 9, 2013

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Bank Loan Servicing & Sales ($M)

Total Loans Serviced 1-4 Family Loans Sold

7,000,000

6,000,000

5,000,000

4,000,000

3,000,000

2,000,000

1,000,000

0
Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012

Source: FDIC Quarterly Banking Profile (12/31/2013)

April 9, 2013

13

Non-Bank Securitization ($B)

450 RMBS/Other 400 Equipment Credit Card Student Loan 300 Auto 250

350

200

150

100

50

0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Deutsche Bank, Thomson Reuters, Bloomberg (12/31/2013)
April 9, 2013

14

Households and Homeownership Rate

April 9, 2013

15

Basel III, Dodd-Frank & Housing

New bank capital regulations are offsetting benefit of QE

Basel III and other regulations literally forcing commercial

banks out of real estate sector, creating huge opportunity for non-banks

The total amount of credit provided to the US housing

sector directly by banks and indirectly via private label securitizations has not recovered

Non-banks have an enormous opportunity to take share,

customers from commercial banks in new loan origination and loan servicing sectors

Hundreds of billions of dollars worth of loans, MSRs and

other assets likely to be sold by banks next three years, remaking the residential mortgage market
April 9, 2013

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Basel III and Housing

Basel III risk weights negative for credit availability to housing

LTV Ratio
0-59% 60-79%

Category 1 Risk Weight

35% 50%

Category 2 Risk Weight

75% 100%

80-89%
90-100%

75%
100%

150%
200%

Source: BIS, Board of Governors (12/31/2012)

April 9, 2013

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Basel III, Risk & Housing

Basel III, Dodd-Frank Offset Fed Efforts via QE

Credit: Basel III places big premium on AAA rated,

Low-LTV, prime assets across the board. Residential mortgages have 10x risk weight vs. Basel 2.5

Liquidity: Market risk is big factor under Basel III, forcing

banks into shorter duration prime assets (floaters, ARMs, short CMOs) and commercial assets such as auto loans and credit cards

Capital: AOCI filter under Basel III also pushes banks into
shorter duration assets (autos, credit cards, prime loans)

CFPB: New rules for qualified mortgage push lenders

into prime loans, discourage non-QM lending by banks

April 9, 2013

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Conclusion
Q: Is QE Behind the Recovery in Housing? A: Yes

QE has changed investor risk preferences

Large investor participation in market for residential homes

Mom & Pop, institutional investors involved broadly in price rally

Recovery is not supported by traditional fundamentals

Declining bank lending, agency volumes Weak employment, GDP, home ownership

End of bank refinancing boom not a function of QE

Policy drivers behind refinancing boom have run course Streamlined refinancing rules likely to have modest impact in 2013

Falling yields may cool investor passion

Gross yields on public rental strategies imply net 4-5% net returns HPA seen in 2012-2013 may not be easy to capture

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Contact Information

Christopher Whalen Managing Director & Executive Vice President Carrington Investment Services LLC 599 West Putnam Avenue Greenwich, CT 06830 Office: 203-661-6186 chris.whalen@carringtonis.com

April 9, 2013

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