Real Estate Third Quarter 2014 Supplement

REAL ESTATE
THIRD QUARTER 2014

INTRODUCTION
Welcome to the latest edition of Bloomberg Brief: Real Estate focused on the
main trends in the residential and commercial markets.
In this issue, former FDIC Chief William M. Isaac explains how the latest recov-
ery differs from prior cycles and why the home price rebound has been muted.
Fannie Mae’s Tom Seidenstein and Steve Deggendorf outline their expectations
for credit standards in residential housing finance, and Bloomberg economist
Josh Wright explains why MBS spreads won’t widen much as the Fed reins in
purchases and housing agencies trim portfolios.
Then there are what Michelle Meyer, economist at Bank of America Merrill
Lynch, refers to as the “Boomerang Borrowers.” These former homeowners who
lost houses through a foreclosure or short sale and want to return as owners
are finding that credit is harder to get. This in turn could have an impact on de-
mand for new and existing homes. As Meyer points out, nearly 17 percent of all
homeowners with a mortgage in 2006 fell into either foreclosure or short sale.
On the residential and commercial real estate finance side, the picture con-
tinues to improve. Financing costs for office and retail property borrowers have
dropped thanks to lower AAA- and BBB-rated CMBS spreads.
Some of the narrowing in CMBS spreads is tied to demand from investors
looking for extra yield at a time when U.S. Treasury 10-year debt yields 2.36
percent and the 30-year yields just over 3 percent.
The yield hunt may also explain lower CMBS issuance. According to Jefferies’
Lisa Pendergast, a greater number of investors financed commercial property
purchases and retained the loans on their own balance sheets rather than sold
them. This forced participants to cut expectations for 2014 CMBS issuance.
The appetite to put money to work in commercial real estate finance shows up
in other ways, notably heightened use of interest-only and partial IO loans. Just
over half of the mortgages resold into CMBS so far this year allowed borrowers
to pay just interest, or had partial-IO characteristics.
– Aleksandrs Rozens, Editor
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Please note you are reading a sample of our
latest Q3 2014 Real Estate Brief.
For the full Q3 2014 edition please visit
www.bloombergbriefs.com/real-estate or contact
us on the numbers below:
Contact us at:
Annie Gustavson
agustavson@bloomberg.net
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212-617-3003

11.17.14 www.bloombergbriefs.com Bloomberg Brief | Real Estate 3
HOUSING UNCERTAINTY ERODES ECONOMY
Uncertainty about regulation has crimped hous-
ing finance and other types of lending, which may
be dampening the U.S. economy, says FTI’s Wil-
liam Isaac.
PAGE 6
BOOMERANG BORROWERS
Demand for housing from consumers who lived
through foreclosures will be modest, according to
Michelle Meyer, senior U.S. economist at Bank
of America Merrill Lynch.
PAGE 8
CMBS ISSUANCE OUTLOOK
Lisa Pendergast, co-head of CMBS strategy at
Jefferies, says issuance may fall short of expec-
tations as lenders keep loans on balance sheets
instead of reselling them as bonds.
PAGE 9
CREDIT STANDARDS EXPECTED TO FALL
A decline in application activity likely will prompt
mortgage lenders to ease credit standards, ac-
cording to Tom Seidenstein and Steve Deggen-
dorf at Fannie Mae.
PAGE 10
MBS AND THE FED
Demand for residential mortgage bonds is
expected to be robust enough to rein in MBS
spreads even as housing agencies wind down
their portfolios and the Fed pulls back from MBS,
writes Bloomberg Economist Josh Wright.
PAGE 12
REFINANCINGS AND CMBS LEVERAGE
Refinancings, a key source of profit for lenders,
have not bounced back even as mortgage rates
skirt historic lows. Use of interest-only and partial
IO loans accounted for just over half of all com-
mercial property debt resold into CMBS.
PAGE 13
FOCUS ON HOMEBUIDERS
Some homebuilders may benefit from recent
policy moves aimed at expanding the availability
of mortgage credit.
PAGE 14
HOME PRICES AND MBS TRENDS
Bloomberg’s Michael Morrissey looks at the
future direction of U.S. home prices and whether
MBS spreads are rich to swaps.
PAGES 16-17
AGENCY COLLATERAL AND CMBS SPREADS
The amount of agency debt resold into CMBS
fell, reflecting a pickup in private label financing of
multifamily properties. CMBS spreads narrowed
on demand from investors looking for extra yield
and issuance of commercial mortgage bonds rose.
PAGES 18-19
CMBS ANALYSIS
Bloomberg application specialist Ting Chen looks
at how CMBS are impacted by retailers that have
announced store closures and retail property
mortgage loan to value ratios.
PAGE 20
CAP RATES
Cap rates for retail property loans and hospitality
loans fell. Office property cap rates rose to a high
not seen since the first quarter of 2012.
PAGES 22, 24
FOCUS ON REITS
Apartment REITs have turned to development
in lieu of acquisitions to fuel growth and some
of that was reflected in September’s 19 percent
jump in multifamily building starts. Office property
values are getting a boost in demand from non-
U.S. buyers.
PAGES 25-26
RESIDENTIAL MORTGAGE DELINQUENCIES
Delinquency rates for U.S. single-family mort-
gages fell in the second quarter of 2014 from
year-ago levels, while low borrowing costs failed
to stoke buyer requests for home loans.
PAGE 28
COMMERCIAL PROPERTY DELINQUENCY,
FORECLOSURE RATES
Industrial property foreclosure rates dropped to
lows not seen since April 2010 and hotel delin-
quencies were unchanged in the second quarter.
PAGES 30-31
TOP UNDERWRITERS OF
DELINQUENT MORTGAGE DEBT
Among underwriters of commercial mortgage
loans resold as CMBS, LaSalle had the largest
number of delinquent loans as of Aug. 4.
PAGE 32
PRIVATE EQUITY AND HEDGE
FUND MANDATES
An increasing number of fund of funds are seek-
ing to put money to work in hedge funds that
invest in mortgage backed securities.
PAGE 34
Bloomberg Brief Real Estate Supplement
Newsletter Ted Merz
Executive Editor tmerz@bloomberg.net
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BY THE NUMBERS
4.16% rate for 30-year fixed rate mortgage loans in
September 2014.
4.49% rate for 30-year fixed rate mortgage loans in
September 2013.
Source: AIA, Freddie Mac, MBA, Fannie Mae, National Association of Realtors
$8 billion net equity cashed out
during refinances of conventional home
mortgages in the third quarter of 2014.
$5.6 billion net equity cashed
out during refinances of conventional home
mortgages in the second quarter of 2014.
$84 billion net equity cashed
out during refinances of conventional home
mortgages in the second quarter of 2006.
9% of homes on the market that were
for sale by owner in 2014, unchanged
from 2013.
18% homes on the market that were for
sale by owner in 1997, a peak.
88% buyers financing their home
purchase in 2014.
31 median age of first-time home
buyers in 2014, unchanged from 2013.
54 typical age of home seller in 2014.
53 typical age of home seller in 2013.
17% of home owners in 2014 who
wanted to sell their home earlier but
were stalled because the home was
worth less than the mortgage.
13% of home owners surveyed in
2013 who wanted to sell their home
earlier but held off because their home
was worth less than their mortgage.
increase in commercial
property sales in Q3 2014
from Q3 2013.
National Association of Home Builders’
remodeling market index reading in Q3
2014, the sixth consecutive reading above
50, which suggests more remodelers
report higher market activity than those
reporting it lower.
57
7.4%
Fannie Mae stock value
on March 10, 2014, the
highest since 2008.
$5.82
Fannie Mae stock
value on Oct. 2, a
one-year low.
$1.51
55.8 Architectural billings index tracking nonresidential construction
activity in July 2014, the highest since July 2007 when it was 57.7.
A value above 50 indicates an increase in activity.

Q&A: FTI CONSULTING’S WILLIAM ISAAC
Uncertainty about regulation has crimped hous-
ing finance and other types of lending, which may
be dampening the U.S. economy, William M.
Isaac, senior managing director of FTI Consult-
ing and former banking regulator, told Bloomberg
Brief’s Aleksandrs Rozens.
Q: How do you feel about the latest
turnaround since the credit crisis?
A: It is really hard to generalize because
real estate is for the most part local. I
live in Sarasota and even within Sara-
sota it is local by neighborhood. If you
live on the water, you’re pretty good. If
you live in other parts of town, things
are not so good. A lot of the real estate
that went through foreclosure has been
purchased by investors, not by owners.
You wonder how much of that really has
been tucked away safely. If Blackstone
or some other big firm comes in and
buys a thousand houses, you can’t really
be comforted because at some point
those houses are going to come back
into the market. They are not owner oc-
cupied and somebody has invested in
them hoping to flip them.
Q: What’s different this time?
A: In the 1972 to 1974 period and in the
1980s, real estate hit a bottom. Banks and
thrifts went out of business by the hun-
dreds if not the thousands. The govern-
ment took over their bad real estate and it
was sold off at rock bottom prices. It had a
good run following that. This time, I don’t
think we had the clearing in the country
that we had in those previous crises. We
didn’t allow things to hit a bottom. We
put a lot of pressure on banks to stop
foreclosing and work out ways for people
to stay in their homes. It may be why we
haven’t seen prices come way up.
Q: What happens to Fannie
and Freddie?
A: In the Senate what they tried to do was
to put them back in the marketplace and
create an FDIC-like fund to cover extraor-
dinary losses in the future.That didn’t go
anywhere and likely won’t. Do you want to
go ahead and nationalize them and make
Former Regulator Says Housing May Not Have Bottomed, New Rules Crimp Lending
Education: B.S. (Miami University, Oxford, Ohio, 1966), JD (College of
Law, The Ohio State University, Columbus, Ohio, 1969)
Career as regulator: FDIC Chief (1978-1985), chairman Federal Finan-
cial Institutions Examination Council (1983-1985), Member of Deposi-
tory Institutions Deregulation Committee (1981-1985), Member of Vice
President’s Task Group on Regulation of Financial Services (1984)
them publicly-owned entities or do you
want to totally privatize them? Those seem
to be the two major options.There seems
to be a pretty strong agreement that you
don’t want them to be a mixture.That got
us into trouble last time.They were suppos-
edly private entities with private ownership,
with private sector type compensation,
but everybody believed that they were
backed by the government if they ever got
in trouble. It wasn’t clear what they were. I
think we really need to be clear about that.
Either they are private entities and ought
to be run like private entities and capital-
ized like private entities, or they ought to be
public entities and we ought to not pretend
they are private entities and their compen-
sation packages ought to look more like
public entities than private entities.They
probably operate with a balance sheet that
is not as strong as it would have to be if
they were private entities.
Q: More people are priced out of loans
because of how lenders underwrite
mortgages. Is that in response to uncer-
tainty in the regulatory environment?
A: Absolutely.You can price anything if
you know what the terms are. There may
be millions of people who got mortgages
the last time around who aren’t going to
get them this time.
Q:Ten years ago some 60 percent of all
mortgage loans were underwritten by
independent brokers. Now that lend-
ing is consolidated with fewer lenders,
what does that mean for housing?
A: Banks have tightened their standards
considerably and it is getting harder and
harder for people in the low-to-middle-
income category to qualify for credit,
whether it is for a home loan or a car loan
or an installment loan. It is getting harder
and harder to get access to credit. Banks
are de-risking, which basically means
dumping customers. They are not dealing
with people who really need credit. That’s
a drag on the economy. It’s one of the
things that’s keeping the economy from
recovering and it’s due to a lot of factors.
One of them is we have increased capital
requirements in banks and liquidity re-
quirements in banks significantly higher.
Q: Why are lenders doing this?
A: Banks are saying we have to be a lot
more selective about our customers. We
only have so much capital we can devote
to this business under the new guidelines,
so let’s start dealing with customers where
we have less risk of loss. That tends to be
the upper echelon of potential borrowers
that get the money. Roughly 71 million
people in this country, or over 25 percent
of the adult population — this is an FDIC
study — are either totally unbanked or
underbanked. They don’t have adequate
access to the banking system.
“Banks are de-risking which
basically means dumping
customers. They are not
dealing with people who
really need credit.”

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The U.S. housing crisis saw millions lose
their status as homeowners. We estimate
that nearly 17 percent of all homeowners
with a mortgage in 2006 fell into either
foreclosure or short sale. Although the
foreclosure pipeline has declined consid-
erably, there are still a number of seriously
delinquent mortgages, suggesting further
liquidations to come.
The path of these households after fore-
closure or short sale and their decisions
in coming years are important for under-
standing the trend in homeownership and
home sales. The majority of former owner-
occupiers became renters. However, some
also doubled-up with other households for
a time, given the weakness in the econ-
omy. We have seen a net creation of 6.5
million renters from 2007 at the expense
of 2.3 million owners. Another way to think
about it is that the homeownership rate
has tumbled to 64.3 percent while the
rental rate, which is the mirror image, has
increased to 35.7 percent.
Are these households stuck as renters
or will they attempt to enter the owner-
ship market once again? On the one
hand, these were previous homeowners,
meaning they may have a proclivity for
ownership once the scars from the crisis
heal. However, they have witnessed a
sharp decline in home values, which may
have prompted them to rethink the risks of
homeownership. The truth is that, in many
cases, these households may not have
the choice.
When borrowers go through foreclosure
or a short sale, their credit is impaired.
There are strict rules for receiving financing
after credit impairment, otherwise known
as being a “boomerang borrower.” To
qualify for a conforming mortgage after a
short sale, borrowers must wait two years
with a 20 percent down-payment, four
years with 10 percent and seven years with
5 percent. Borrowers who went through
the foreclosure process typically must wait
seven years.There are circumstances
where the timeline is quicker, such as in
event of divorce or the loss of a spouse.
According to research by Experian, there
have been few boomerang borrowers thus
far. For the 5.43 million properties that
went through foreclosure in its sample, only
2.1 percent of the borrowers, or 114,100
Not Much Boom in Boomerang Borrowers
HOME OWNERSHIP MICHELLE MEYER, SENIOR U.S. ECONOMIST, BANK OF AMERICA MERRILL LYNCH
0.3%
0.5%
0.8%
1.0%
1.3%
1.5%
0%
1%
2%
3%
4%
5%
6%
1995 1998 2001 2004 2007 2010 2013
Mortgage Payments Past Due 90+ days (Left Axis)
Mortgage Foreclosures Started (Right Axis)
Source: Mortgage Bankers Association, BAML
Delinquent Mortgage Levels Remained High
29
30
31
32
33
34
35
36
37
62
63
64
65
66
67
68
69
70
1980 1985 1990 1995 2000 2005 2010
Percent
Percent
Homeownership rate (Left Axis)
Rental rate (Right Axis)
Source: Census Bureau, BAML
Homeownership Fell to Near 20-Year Low as Rentals Jumped
households, had purchased a primary
home by the end of last year. Of the nearly
800,000 short sales that Experian tracked,
only 5.5 percent of borrowers (44,300) had
returned to the ownership market.
Research from the Federal Reserve Bank
of San Francisco suggests these numbers
are likely to grow, but only modestly.The
authors find that only 30 percent of bor-
rowers who defaulted in 2001 had taken
out another mortgage within 10 years.And
these borrowers experienced more than
a 100-point increase in their FICO score,
showing significant healing. Moreover, the
study covers 2001, right before the hous-
ing bubble when price appreciation was
rapid and credit was easy. In the current
environment with tight credit, the numbers
of borrowers re-entering is likely to be
significantly lower.

Q&A: JEFFERIES’S LISA PENDERGAST
CMBS issuance will be lower than expected in
2014 because more loans are being underwritten
by participants who retain mortgages on balance
sheets, according to Lisa Pendergast, head
of CMBS risk and strategy at Jefferies Group
LLC. She spoke to Bloomberg Brief’s Aleksandrs
Rozens in an interview conducted in late October.
Q: What will U.S. CMBS issuance be
this year?
A: We’ll see somewhere between $95 and
$100 billion.That’s been somewhat of a
roller coaster projection. Initially at the outset
of 2014 I thought we would see at least
$100 billion. Supply truly dried up in the first
half of the year. It really did not open up
until the second quarter, early third quarter
when you started to see all of the originators
increase their volume and that translated
into increased CMBS transactions. Lower
rates are certainly going to entice a number
of borrowers to refinance loans that are
coming due in 2015, 2016 and 2017.
Q:What was behind the decline in sup-
ply in the first half?
A: Competition.The CMBS lenders were
finding it difficult to source product. Early on
in the year, life companies had lots of mon-
ey to spend and they certainly did. In many
cases, what many CMBS lenders realized
they had to do to get that product was to cut
their spreads.You saw pricing on loans re-
ally improve over the course of the first half
of the year.The agencies, the GSEs also
saw a real dip in supply in the first half of the
year. But they have really seen things pick
up over the recent two months.
Q: Beyond life companies, who are the
other big lenders?
A: Banks have come up very strong.The
regional banks are starting to see a nice
pickup in origination volume.
Q:Are they keeping it all on their
balance sheets?
A: Life companies and banks keep it on
their balance sheets.The GSEs generally
securitize and obviously CMBS lenders do
the same.
Lenders Keep Mortgages on Balance Sheets, Putting Limit on CMBS Supply
Career: Previously head of commercial mortgage-backed debt research
at RBS Capital Markets, CMBS research analyst at Prudential Securities.
Favorite pastime: Biking
Last book read: “Ava Gardner: The Secret Conversations” by Ava
Gardner and Peter Evans
Favorite charity: Alzheimer’s Association
Q:A lot more of the collateral in CMBS is
actually agency collateral.Why?
A: It is the multifamily business. It is the
one really seeing a continued strong
transaction volume at the property level. In
multifamily, as opposed to other markets,
borrowers are comfortable moving beyond
core markets and the safety of those core
markets. It opens up possibilities for loan
originations to pick up, given secondary
markets some of these multifamily inves-
tors are now focused on.
Q: How does the gravitation towards
renting affect this?
A: Homeownership is now in the 64 and
change area. It reached almost 69 percent at
the peak of the single-family housing boon.
We may be experiencing a singular shift
back toward a lower homeownership rate.
There are all sorts of drivers behind multi-
family demand, including the millennials out
there who are ready to leave the nest as the
economy improves and move into rentals.
You have baby boomers who are retiring
and moving into urban areas where you are
more likely to rent than own.You have huge
immigration inflows that are a big driver of
multifamily demand.Then there are those
who cannot afford to buy a home.
Q: More of the debt resold into CMBS is
in the form of IOs or partial IOs.What’s
your take on leverage?
A: The life companies have become mildly
more aggressive but they have not really left
their comfort zone. In the CMBS market I
do think that leverage is approaching levels
we saw in 2007.The difference is, gener-
ally speaking, the leverage is much more
grounded than it was back then. Underwrit-
ing is a lot more conservative, even though
leverage points are starting to creep up
and that has directly to do with heightened
competition for loans.
Q:What is your outlook for
CMBS spreads?
A:You are going to see guys less afraid of
duration given the rate environment.The
AAA 10-year has gotten as tight as 74.We
currently have it around 88. So, you could
see spreads tighten into that level.There are
investors that are pushing back from some
of these credits. Some deals will price in
the 90s and other deals will price in the mid
80s.The market is being selective where
it can. On better deals we could go back
to tights of the year in the mid 70s on the
10-year. On the BBB- we are at sort of an
average of 345.The tight has been 290 so
its possible we get to the low 300 area, but
it really depends on a variety of things. Life
companies either need to either change
their bogey of around 4 percent or they are
out.You have a 10-year swap rate in the
240 area and then you add 90 to that and
you are at 330.You are way off from that 4
percent.They have other places to put cash
and that may be where they focus.
“In the CMBS market,
leverage is approaching levels
we saw in 2007.”

MORTGAGE CREDIT STANDARDS TOM SEIDENSTEIN AND STEVE DEGGENDORF, FANNIE MAE
Larger Lenders Expect to Ease Mortgage Credit Standards as Demand Weakens
Many commentators cite tightened mort-
gage credit standards as a reason behind
the slow pace of the economic and housing
recovery.This naturally raises the question
of when and if credit standards will loosen.
Fannie Mae’s Third Quarter 2014 Mort-
gage Lender Sentiment Survey (MLSS),
conducted during August, finds that credit
conditions may already be evolving. Survey
results show a higher proportion of larger
lenders have eased than have tightened
single-family credit standards in 2014.This
is occurring against a backdrop of anticipat-
ed tepid demand, with lenders of all sizes
reporting expectations have slipped for
single-family purchase mortgage demand
during the next three months.
Among larger lenders surveyed, more
report easing than tightening of credit stan-
dards across all loan types (GSE eligible,
non-GSE eligible and government loans).
This easing tendency of larger lenders
during the past three quarters is not yet
so evident among mid-sized and smaller
lenders.As an illustration, for non-GSE
(government-sponsored enterprises — in
this context, Fannie Mae and Freddie Mac)
eligible loans, 33 percent of responding
larger lenders say they have eased credit
standards, compared with 13 percent who
say they have tightened.
A greater share of larger lenders also ex-
pect to ease than to tighten credit standards
over the next three months. Increased
competition was cited as the most common
reason for easing lending standards.
With the housing market recovery quite
gradual, lenders face a more competitive
market for loan volume. In August 2014,
Fannie Mae’s Economic and Strategic Re-
search Group released an in-depth special
topic analysis from its second quarter 2014
MLSS, which shows that larger lenders
are more likely than mid-sized and smaller
lenders to pursue non-QM (Qualified
Mortgage) loans. Our third quarter 2014
MLSS suggests that some larger lenders
may be tapping into the Non-GSE eligible
and government loan market to offset their
expectations for lower consumer demand in
the last months of this year.
In the third quarter 2014 MLSS, many
more lenders said consumer purchase
mortgage demand was up rather than
down for the prior three months. However,
the share of lenders who expect purchase
mortgage demand to go up over the next
three months decreased significantly quar-
ter to quarter, with the largest share decline
of this opinion at 33 percentage points for
GSE eligible loans.
Overall, lenders’ diminished sentiment
about the housing market is broadly in line
with Fannie Mae’s Economic and Strategic
Research Group’s 2015 housing forecast.
(Tom Seidenstein, vice president, and Steve
Deggendorf, director, are with Fannie Mae’s
Economic and Strategic Research Group.
Views expressed are their own and figures are
the responsibility of the authors)
25% 25%
33%
51%
63%
54%
24%
11% 13%
Q1 Q2 Q3
Eased Remained Unchanged Tightened
Source: Fannie Mae
Larger Institutions Mid-Sized Institutions Smaller Institutions
13%
16%
23%
47% 53%
64%
41%
30%
13%
Q1 Q2 Q3
3%
16%
19%
60%
64%
53%
37%
21%
27%
Q1 Q2 Q3
Credit Standards Direction, Non GSE-Eligible Loans by Volume
59%
54%
21%
35%
43%
66%
6%
4%
13%
Q1 Q2 Q3
Go up Stay the same Go down
Source: Fannie Mae
52%
53%
27%
44%
42%
61%
4%
5%
12%
Q1 Q2 Q3
51%
42%
16%
42%
50%
67%
7% 7%
17%
Q1 Q2 Q3
GSE Eligible Loans Non-GSE Eligible Loans Government Loans
Purchase Mortgage Consumer Demand by Share of Institutions

With the publica-
tion of its “policy
normalization”
principles along-
side its September
FOMC statement,
the Fed made clear
its intention to wind
down its portfolio of
mortgage-backed
securities (MBS), through a multi-year,
passive process that will begin no sooner
than the Fed’s rate hikes.
A reasonable question to ask is: without
the Fed’s activity in the MBS market,
where will mortgage rates go, especially
as the GSEs’ portfolios continue to wind
down? Not far, as the decrease in quasi-
governmental support will be outweighed
by a decline in MBS issuance and de-
mand from other fixed income investors.
We can break the mortgage rate into two
or three components: the underlying risk-
free Treasury rate, the spread of MBS rate
(the “secondary rate”) over Treasury yields
and the spread of the “primary” mortgage
that consumers face over the MBS rate.
The outlook for the first component, the
level of long-term Treasury yields, has
undergone a dramatic reversal this year,
from a mantra that “rates must rise” as
the Fed begins tightening to a growing
conviction that Treasury yields will remain
suppressed for some time by shifts in sup-
ply as well as regulatory and geopolitical
factors.
As for the second component, the
spread between mortgage rates and Trea-
sury yields, a quick review of the funda-
mentals makes a strong case that this will
remain tight over the medium term. Most
important are the supply dynamics. The
aggregate net issuance of agency MBS is
likely to remain modest.
As of June, the Mortgage Bankers
Association projected total mortgage
originations for 2014 at $1.02 trillion — a
42 percent decrease from 2013 and the
lowest annual total for mortgage origina-
tions since 1997.
Moreover, mortgage growth is expected
to be tepid for the foreseeable future, in
light of concerns about slower house-
hold formation, shifting attitudes towards
Mortgage Rates Can Ride Out Fed, GSE Portfolio Contraction
FED IMPACT ON MORTGAGES JOSH WRIGHT, BLOOMBERG ECONOMIST
Primary-Secondary Mortgage Spread Begins to Narrow
0
10
20
30
40
50
60
70
80
90
0.0
0.5
1.0
1.5
2.0
2.5
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Mortgage Basis (Right Axis)
Primary-Secondary Spread (Right Axis)
Swaption-Implied Volatility (3m-10yr) (Left Axis)
Source: Bloomberg, Freddie Mac
Percent
BasisPoints
homeownership, lingering weakness in
existing household balance sheets and
higher millennial student debt loads.
Already relegated by Treasuries to the
second-largest fixed-income market in the
world, agency MBS are unlikely to regain
the lead for the foreseeable future.
The demand side also looks set to sup-
port agency MBS spreads. The Fed is ex-
pected to wind down its portfolio of MBS
very gradually, over the course of about
five years, starting about a year from now
(once the Fed begins raising rates). That
would imply net paydowns – that is a net
increase in the tradeable float of agency
MBS – of perhaps $10 billion a month to
$20 billion a month from mid- to late-2015
until about 2020. In the meantime, the
Fed’s unhedged holdings will continue to
absorb not only duration but negative con-
vexity from the market, depressing implied
volatility and therefore MBS spreads.
Concurrently, the GSEs’ portfolios are
scheduled to contract from a combined
$873 billion as of the second quarter to a
maximum combined $500 billion by the
end of 2018.
That would imply only roughly $7.5 billion
a month, and those paydowns will not
have the same duration and convexity
impacts as the Fed’s paydowns, since the
GSEs actively hedge their portfolios. Also,
their net decline of $373 billion is about
half as small as the $719 billion that the
GSEs’ portfolios have already contracted
since their peak at the end of 2008.
Meanwhile, numerous forces are align-
ing to replace the lost demand from the
Fed and the GSEs.
In developed economies, new capital
and liquidity regulations will support banks’
demand for agency MBS and retiring Baby
Boomers are shifting their investment
portfolios to fixed income. From emerg-
ing markets, East Asian sovereign wealth
funds and a growing global middle class
will continue to seek high-quality assets.
With Treasury issuance set to decline
in the short-term, that will only increase
demand for Treasury-like securities.
As for the third component, the so-called
primary-secondary spread between mort-
gage rates and MBS yields, this has been
pushed wider in recent years by a host of
structural shifts in the mortgage origina-
tion and servicing business.
These include changing regulations and
higher risks of litigation or credit losses
associated with GSE putbacks. As the le-
gal environment stabilizes and the GSEs
recalibrate their policies, this spread
should stabilize, if not retrace.

MORTGAGE TRENDS
3.80
3.90
4.00
4.10
4.20
4.30
4.40
4.50
4.60
4.70
4.80
1,200
1,300
1,400
1,500
1,600
1,700
1,800
1,900
2,000
2,100
2,200
12/13 1/14 2/14 3/14 4/14 5/14 6/14 7/14
Percent
MBA Refinance Index (Left Axis)
30-Year Mortgage Rate (Right Axis)
Source: Mortgage Bankers Association
Low Mortgage Rates Fail to Stir Up Massive Refinance Wave
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2000 2002 2004 2006 2008 2010 2012 2014
Partial IO IO Balloon Fully Amort
Source: Bloomberg LP
*Transactions completed as of August 2014
*
CMBS Loan Leverage Little Changed From 2013 Levels
Requests for Loan Refinancings Decline Even as Borrowing Costs Skirt Historic Lows
Requests for home loan refinancings
have drifted lower this year, damping a
key source of profit for many lenders.
The Mortgage Bankers Association’s
measure of requests for home loan
refinancings, its refinancing index, was at
a reading of 1,693.2 in late January. The
refinancing index fell to a reading of 1,377
in late August.
Mortgage rates have generally been
below 4.5 percent in 2014, failing to bring
about a dramatic increase in requests for
loans refinancings among home owners.
The most notable jump in refinancings in
the first three quarters of 2015 was evident
in June a week after 30-year mortgage
rates hit 4.26 percent; applications for
home loan refinancings jumped and the
refinancing index rose to 1,528.9.
Mortgages for U.S. commercial proper-
ties that allowed borrowers to pay only
interest or had partial-IO characteristics
accounted for just over half of all debt
resold into CMBS in 2014.
That is little changed from 2013 and
suggests that lenders are increasingly
hungry to put money to work in a low
interest rate environment. The heightened
use of IO loans comes as more lenders
like insurance companies underwrite
loans and keep them on their own bal-
ance sheets as opposed to resell them as
securities.
The use of IO and partial-IO mortgages
was at its highest level since 2007 when
over 80 percent of commercial property
loans fell into this category.
:::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::SUBSCRIBE TO BLOOMBERG BRIEFFOR THE LATEST NEWS, INFORMATION, ANALYSIS AND COMMENTARY.
DELIVERED TO YOUR INBOX EVERY MORNING.

HOME BUILDING DREW READING, BLOOMBERG INTELLIGENCE ANALYST
-20
-10
0
10
20
30
40
50
60
70
80
2007 2008 2009 2010 2011 2012 2013 2014
IndexLevel
SDRMTGTP Index
Source: Federal Reserve, Loan Officer Survey
Banks Tightening
Banks Loosening
More Loan Officers Still Loosening Than Tightening: Survey
0 20 40 60 80 100
TRI Pointe Homes
Meritage Homes
Taylor Morrison
Pulte
Standard Pacific
Ryland
Hovnanian
William Lyon Homes
Lennar
M/I Homes
D.R. Horton
MDC
KB Homes
LGI Homes
Percent First-Time Buyers
Source: Company Filings, Bloomberg Intelligence
LGI Sells 100% of Homes to First-Time Buyers
Banks Remain Reluctant to Relax Mortgage Lending
While lax lending standards were a key
catalyst to the collapse of the U.S. housing
market, the pendulum may have swung too
far in the opposite direction, leaving many
would-be homebuyers unable to qualify for
mortgage financing.
Banks have been reluctant to offer loans
due to repurchase risk, in which banks
must buy back bad loans.There have been
only modest signs of more relaxed lend-
ing among U.S. banks to date, the Federal
Reserve’s Loan Officer Survey Shows.
The long-awaited Qualified Residential
Mortgage Rule finalized last month did not
includeadisputedprovisionrequiringbanks
to hold risk for mortgages without a 20 per-
cent down payment.The rule is expected to
draw more private capital into the residen-
tial mortgage market.
Builders Get Boost Amid Looser Credit, Particularly for Entry-Level Buyers
U.S.homebuildersmaybenefitfromrecent
policymovesaimedatexpandingmortgage
credit availability.
Strict lending standards have been one
of the primary impediments to a more
robust housing recovery. In particular, new
guidelines may support greater lending
to first-time homebuyers, who have been
noticeably absent from the market.
Greater clarity may be coming at just the
right time as the homebuilding spring sell-
ing season is approaching.
LGI Homes reports approximately 100
percent of its sales are to first-timed home
buyers.

NICHELLE MCCALL, CEO
BOLD GUIDANCE
1621 EUCLID AVE
Downtown Cleveland
MYADDRESS
CONNECTSIDEAS
TOCAPITAL.

The recent rebound in home prices and
Fed tapering have led many to question if
home prices are vulnerable to a decline.
The Housing Affordability Composite
Index from the National Association of
Realtors shows that affordability was low in
the 1980s until real estate prices dropped
between 1989 and 1993. For most of the
next 10 years, affordability remained stable
with the index in a 125-145 range.
From 2003 to 2007, affordability dropped
with a run up in real estate prices.A subse-
quent collapse in home prices and drop in
interest rates led to unprecedented levels of
affordability, which peaked in early 2012.
After a rebound over the next two years,
affordability has not yet returned to the
125-145 range, suggesting that there may
be more upside depending on median
household incomes and interest rates.
The index tracks the affordability of
housing, typically based on a mix of
median home prices, median income
and mortgage rates.
HOME PRICES MICHAEL MORRISSEY, CFA, BLOOMBERG APPLICATION SPECIALIST
100
120
140
160
180
200
220
1986 1989 1992 1994 1997 2000 2003 2006 2009 2012
HousingAffordabilityIndex
Source: National Association of Realtors
Home Prices May Rise More as Affordability Still High
100
120
140
160
180
200
220
2000 2002 2004 2006 2008 2010 2012 2014
Indexlevel
Normalized CPI
S&P/Case-Shiller home price index
Compound normalized CPI
Case-Shiller Outpaced Inflation Before Crisis
Another way to look at home prices is
to compare them to inflation. Over the
long term, home prices typically rise by 2
percent over CPI annually.
Normalized CPI as measured by the
Bureau of Labor Statistics has moved to
140 from 100 since January 2000.Adding
2 percent per year to the CPI would lead to
a level of 180.
Overlaying the S&P Case Shiller 20
Home Price Index shows home price in-
creases clearly outpaced inflation and the
long-term rate (2 percent over CPI) before
the market repriced from 2007-2009.
What is also notable is that the Case
Shiller Index bounced off CPI before head-
ing higher.
Assuming 2 percent a year increases in
CPI, home prices may have some upside
relative to inflation. Changing the
assumption to 1.5 percent annual rises,
home prices are at fair value.

MBS TRENDS MICHAEL MORRISSEY, CFA, BLOOMBERG APPLICATION SPECIALIST
Low mortgage rates have helped the
housing market recover. The most com-
mon measure of broad MBS value is the
mortgage basis, the difference between
current coupon yields and a risk-free
benchmark.
The risk-free rate is derived from
blended swap rates on the five- and
10-year to match duration of Fannie Mae
30-year pools.
Fed MBS purchases have kept spreads
tight and pushed down the current
coupon yield.
The mortgage basis, at 90 basis points
over swaps, is approximately 40 basis
points tighter than its widest level at the
end of 2013.
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14
Percent
Percent
Current Coupon (Left Axis)
5/10 Swaps (Left Axis)
Mortgage Basis (Right Axis)
MBS Trading About 40 Basis Points Tight to 2013 Peak
0.6
0.8
1.0
1.2
1.4
1.6
1.8
Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14
Mortgagebasis(bp)
5-year average
MBS Spreads Rich to Swaps Compared to Five-Year Average
Looking at the same spread over the last
five years would suggest that MBS is rich
relative to swaps.
Spreads are unusually tight due to a
limited supply of mortgage origination and
strong demand from the Fed through the
QE programs.
The tightening of spreads in 2012 was a
direct result of people trying to get in front
of the Fed purchases of QE3.
There is potential for spreads widening if
the Fed changes course too quickly.
Track Economic Forecasts ECFC

The amount of agency debt resold into
commercial mortgage-backed securities
(CMBS) fell in the second quarter from the
first quarter, reflecting a pickup in private
label financing of multifamily properties.
The amount of conduit debt resold into
securities fell in the second quarter to
$11.48 billion, a low not seen since the
fourth quarter of 2012, according to data
compiled by Bloomberg.
Use of large loan flaters fell to the lowest
since the third quarter of 2013.
In the second quarter, $12.08 billion
worth of agency collateral was repack-
aged into commercial mortgage bonds,
down from $12.83 billion in the first quar-
ter and from $19.26 billion in the year-ago
quarter.
0
5
10
15
20
25
30
35
40
45
2012
(Q1)
2012
(Q2)
2012
(Q3)
2012
(Q4)
2013
(Q1)
2013
(Q2)
2013
(Q3)
2013
(Q4)
2014
(Q1)
2014
(Q2)
HistoricalIssuanceVolume($Billions)
European Large loan floaters Conduit Agency
Agency Collateral Use Declines in Q2 From Q1,Year-Ago Levels
CMBS YIELD PREMIUMS, COLLATERAL
Spreads of AAA-rated and BBB-rated
bonds backed by commercial real estate
property loans narrowed from the same
period last year because of a pickup in
demand by investors seeking extra yield.
In June, AAA-rated CMBS were at 52
basis points over swaps, in from 58.5
basis points in March and 80 basis points
in the second quarter of 2013.
BBB-rated CMBS were at 205 basis
points over swaps, in from 223 basis
points in March and 450 basis points in
the second quarter of 2013.
0
100
200
300
400
500
600
2/1/2013 5/1/2013 8/1/2013 11/1/2013 2/1/2014 5/1/2014
SpreadsVersusSwaps(BasisPoints)
BBB-rated CMBS* AAA-rated 5 Year CMBS*
Source: Commercial Real Estate Direct - crenews.com
(* CMBS 2.0 and 3.0 Spreads)
U.S. AAA and BBB Rated CMBS Spreads Narrow in Q2
COMPARE LOAN YIELDS FROM YOUR SCRAPED MESSAGES

0
5
10
15
20
25
30
1/2013 5/2013 9/2013 1/2014 5/2014
Issuance($Billions)
All US ($Bln) All Non-US ($Bln)
CMBS Issuance Rose From May to June; Q2 Supply Off Year-on-Year
Issuance of bonds backed by com-
mercial real estate debt in the U.S. rose
to $15.4 billion in June from May’s $12.6
billion and April’s $5.9 billion.
A year ago, $9.99 billion worth of U.S.
commercial mortgage bonds was sold in
June.
Second quarter U.S. commercial mort-
gage backed security issuance totaled
$33.9 billion, down from $36.6 billion in
the first quarter.
In the second quarter of 2013, U.S.
CMBS issuance totaled $40.34 billion.
CMBS ISSUANCE
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