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For the past three and a half days, I have been in Boston at the annual Mortgage Banker Association’s National Secondary Marketing Conference.  At the event, I met with a few of our investors, some vendors and had the opportunity to listen to several speakers who are considered experts in various areas of mortgage finance.  Since it is not possible for everyone to attend events like this, I would like to give you a synopsis of what I learned and what came from the meetings I had with our investors.

The headlines have screamed for a year – the sky is falling and it is all because of, or at least precipitated by the sub-prime lending crisis.  What is the real story and how will this market shake out in the next year or two.

In a speech from Jay Brinkman, the chief economist for the Mortgage Bankers Association, numerous statistics and opinions were given that gave some insight into the current economic status of our country and specifically, the residential real estate and finance markets.

There will be no more rate cuts by the Fed.  Why?  Because, now the attention has turned toward inflation fears and the lower valuation of the US dollar.  Treasury securities are not attractive at the current rates for foreign investors, some of the largest holders of US debt.

 Mr. Brinkman said, “If we are not in a recession, we can certainly see it from here.”

 -         Net Exports are falling
-         Non-Residential investments in real estate are down (this includes office buildings and other commercial structures)
-         Residential investment is falling
-         Inventories have grown this is usually a good thing, but the inventories we have built are American made SUVs so
-         Government spending is up which is usually good for the economy  

The government’s stimulus package should help our Gross Domestic Product (GDP), the amount we spend on US goods and services, but the amount of the injection is not going to add jobs to the economy and sustain the economy.  The stimulus will likely extend the time before some utter the “R” word.

 Strengths in the Current Economy
-         The banking industry is healthy, but capital constraints at the larger banks has made money tight in some areas
-         US companies with international business have done well, although the companies that are purely domestic have not all faired as well.  For a success, we only need to look at John Deere – the demand for farm equipment oversees is very high.
-         Other than in the construction industry, the contraction we have felt is not terribly severe – there have been worse times in recent history.
-         Exports are up, but Net Exports are down Weaknesses in the Current Economy
-         Risks of inflation.  (Expected inflation is a key component of interest rates)
-         Energy prices
-         Uncertainty in tax rates for capital gains and dividend taxes after the presidential election and the additional taxes that are to be put on by states and municipalities
-         Entitlement costs – we have a lot of soldiers and ex-military that will start collecting benefits in the next 5 years.
-         Wage inflation – as baby boomers retire, the supply of skilled workers decreases and drives up wages for those who can replace the retirees.

Unemployment rates continue to show the importance of a college education.  The unemployment rate for people without a highschool diploma is rising and is currently over 8%.  For a high school graduate, unemployment is 5.5%, for those with some college it is 4%.  Those lucky enough to finish college are enjoying a 2% unemployment rate and they have for years.

 The forecast for mortgages is lower for 2008 through 2010.  We had $160 billion in subprime loans originated in 2005-2007 – those loans are obviously gone, but even the prime loans are on the decrease.  In 2008, the forecast is $1.9 trillion, followed by $1.8 and $1.7 trillion in 2009 and 2010 respectively.

New and existing home sales will fall by 14% in 2008 and single family housing starts are down 40%.

Established neighborhoods remain strong as homes built after 2000 make up the vast majority of vacant homes in the nation.  As a lender, older is better many times.

Home price declines have received a huge amount of press.  There are several sources for the information, but one thing they lack is a geographical breakdown of where the price declines are.  As you may have guessed, they are in California, Florida, Nevada and Arizona.  By removing these states from the statistics, things look incredibly different.

Where is there risk for lenders?  Lots of places, but especially in places where the population is migrating from.  The largest migration of people who buy homes are leaving California, Florida, Michigan and Ohio.  While California may appear to be holding steady, in reality they continue to see new immigrants and children of immigrants who will not qualify as potential home buyers.  Another quote from California has become common “Every divorce in California is a bankruptcy.”

There is some good news for lenders.  Many people are thought to be waiting for the real estate market to reach a bottom before stepping into home ownership.  There are a lot of renters in this category.  How can we start marketing to these people now?

Foreclosures are up and especially among those holding the minimum payment mortgage.  Whether option-ARMs or traditional ARMS and regardless of the credit quality, ARMs have a higher default rate than fixed rate loans.  50% of foreclosures are PRIME ARMs. 

Lastly, secondary marketing executives have stated that concerns in the past were severity of loss that comes from a borrower failing to make payments and then going to foreclosure.  The models for predicting that risk have been fairly good.  Investor attention has now turned to frequency, meaning how often is the borrower delinquent and for how many payments before a modification or a work out of some kind is allowed or called for.  I do not imagine many of you have thought about the implications of that, but there is a high cost associated with servicing loans.  If the cost to service loans increases, those increases will be passed to us in higher prices and fees from investors.  FNMA and FHLMC have already raised their fees in response to the additional risks they have identified in their current portfolio along with their need for capital.