Recent comments by Federal Deposit Insurance Corporation (FDIC) Chairman Sheila Blair regarding minimum down-payments of up to 20% for “qualified residential mortgages” (QRM) echoed discussions about residential housing markets at the UGA Timberland Investment Conference. Our Equity Research Team (Neena Mishra, CFA, Director of Equity Research; Dr. Tim Sydor, Forest Economist; and Dr. Brooks Mendell) met to discuss potential issues and implications from this on housing and stumpage (timber) markets:
According to National Association of Homebuilders (NAHB) Chairman Bob Nielsen, the plan would disqualify a number of potential home buyers, reducing home sales and resulting in 50,000 fewer housing starts per year. Changes in mortgage requirements affect housing starts, which in turn affect the forest products industry.
How might this affect timberland investors? Using Forisk’s interactive Stumpage Forecasting models, we applied NAHB’s numbers. The net impact of fewer home built reduces softwood lumber consumption by 1.5 to 1.9 billion board feet per year which could lower softwood sawtimber stumpage prices in the US South by $0.60-0.80 per ton based on direct effects alone. This does not include potential impacts on the shadow inventory of unsold homes and potential foreclosures in the pipeline.
In addition to affecting timber markets, the FDIC/Federal Reserve plan represents a significant shift in risk. From one perspective, any probability of default whether due to job loss or equity loss (so-called “strategic default”) is borne by the buyer in the form of the 20% down-payment. As written the requirement is indiscriminate, even including buyers with high FICO scores. Would rates actually decline as a result?
Requiring lenders to have “some skin in the game” is necessary but risk retention increases the cost of credit. Thus a line must be drawn to determine which loans are less risky and the less risky loans should carry lower rates of interest (possible only if no/very low risk retention by the banks). There is no doubt that QRM loans will carry a much better rate of interest, if the rules are imposed. Overall rates may or may not come down but QRM loans would clearly carry much better rates than non-QRM loans.
The picture is further clouded by the fact that the private securitization market for housing is gasping; securitization brings down the cost of credit and increases the availability of credit. Reviving the private securitization market would be difficult if very strict risk retention requirements are imposed. This is further exacerbated because current rules exempt FHA, Freddie Mac and Fannie Mae loans (while Freddie and Fannie remain in conservatorship) from any risk retention requirement. Currently about 90% of the loans are backed by these agencies, so the actual impact on the housing markets may not be that great. As such, the rules actually favor Freddie-Fannie, making their exit – an oft cited objective of reforming the mortgage markets and reducing tax-payer exposure – from the housing markets anytime soon nearly impossible.
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