MBA Mortgage Purchase Index falls again as bond market selloff continues

The Mortgage Bankers Association (MBA) index of purchase activity measures application activity, not loans made. The Mortgage Bankers Association samples roughly 75% of all mortgage activity in the U.S. and its indices are key indicators for the real estate finance market and home builders alike. The purchase index is released weekly, along with the mortgage applications composite index.

Housing economists use the MBA applications data to forecast numerous economic variables, like existing home sales and new home sales. Originators will use the data for benchmarking their own activity. Mortgage REITs will use the refinance data to forecast prepayment activity, which is a critical factor in mortgage backed security returns. Home builders also will use the purchase index to forecast existing and new home sales. The purchase index tends to lead home sales by four to six weeks.

The MBA Purchase Index fell 3% for the week ending May 17th

Unlike the refinance index, the purchase index is driven by seasonal factors. The real estate cycle starts picking up in April and the selling season peaks in the summer, lasting until late Fall. This year, we have not seen much, if any, drop in the index, which bodes well for the Summer selling season. The purchase index somewhat understates the true activity going on in the market, as a large chunk of the buying has been professionals who are cash buyers. Their activity will not be counted in the index. Given the nearly 12% drop in the refi index last week, only a 3% drop in the purchase index seems relatively robust.

In April, we saw a big decline in interest rates as the March jobs report disappointed and the Bank of Japan launched its own version of quantitative easing (QE). Investors feared that the sequester would crimp second quarter growth. So far, there has been a small effect, but nothing dramatic. However, that trend reversed on the April jobs report which showed a better than expected rise in payrolls. That report seems to have been the catalyst for this bond market sell-off. Combined with generally good earnings, the bond market has suffered from the “risk on” trade, which means investors are selling “riskless” assets, like Treasuries, to buy risky assets, like stocks.

Implications for home builders

Generally speaking, the earnings for home builders, like Lennar (LEN ), Meritage (MTH ) and Ryland (RYL ), were very good. Everyone reported increases in revenues and earnings, and some of the West Coast based home builders, like KB Homes (KBH ), reported 50%-80% increases in backlog. It is important to remember that these numbers are coming from an extremely depressed base. Prior to the housing bust, a housing starts number below one million was observed only rarely, usually at the lowest point of a recession. In March, we rose above one million starts for the first time since 2008. During expansions, it was not unusual to see housing start numbers above two million.

The home builder ETF (XHB ) is up smartly over the past 12 months, but we are still very, very early in the housing recovery. This is because first time home buyers have been absent due to tough credit conditions and a difficult labor market. As those circumstances change, a lot of pent-up demand will be released, which should drive home builder earnings for quite some time.