Baby boomers appear to have a considerable impact on the mortgage basis, said analysts from Barclays Capital in a report released last week "Demographic changes have been a big driver of bank deposit growth, and we believe this will continue, fueling bank appetite for MBS," they wrote.
According to Barclays, the question facing the mortgage market is what factors are driving deposit growth increase and whether the phenomenon will continue. From the data presented by the firm, it becomes clear that bank deposit growth has risen hand in hand with home equity extraction, partly explaining why bank deposits have grown so fast in recent years.
Turnover-based extraction - which involves homeowners moving out of their existing homes - helps explain why a considerable amount of the home equity extracted has ended up in bank deposits. Clearly, an older household that is downsizing is more likely to put some of the extracted equity into more conservative investments, including bank deposits. In fact, in the past few years, the sharp rise in the percentage of overall disposable income has coincided with the increase in older households as a percentage of the U.S. population. Thus, based on this, it would seem reasonable to say that the jump in home equity extraction is being driven by demographic changes, analysts said. Moreover, these aging baby boomers have often been in their homes for decades and have, therefore, experienced significant home price appreciation. As they move into retirement, many extract a significant portion of their equity by either downsizing to a smaller home or renting.
Turnover-based extraction, and not cash-outs, is now the more important form of home equity extraction, analysts said. The data shows that the total share of home equity extracted through cashouts is less than 40% in 2005, despite the fact that 2005 was the year that cash-out refinancing peaked. In fact, analysts noted that even as cash-out refinancing has increased considerably in absolute dollar terms over the past few years, its share of total home equity extraction was lower in 2005 compared to 2001. They explained that cash-outs have been driven by very robust home price appreciation and historically low mortgage rates from 2002 to 2005, a factor that has also kept discount prepay speeds high. But, as rates move higher, and the housing market slows down, cash-outs should dissipate.
Homeowners participating in cash-out refis typically want to extract equity out of their house and put it to work by restoring the household balance sheet (paying down more expensive debt), or for extra consumption or investment purposes. In the firm's view, it is not likely that most of this money is finding its way into bank deposits. "Why take out a new mortgage with a higher rate only to put some of the money into low-yielding bank deposits?" they wrote.
Analysts expect cash-out refinancing to dip as rates rise and the housing market cools. However, this should not have as large an effect on turnover-based home equity extraction. As noted earlier, these are households with decades of home price appreciation built in, so a cooling housing market would matter less to them. Higher mortgage rates would not matter as much as well, since these households typically use some of their home equity extracted to buy a smaller place, or simply rent.
Furthermore, there is also the continued aging of the U.S. population. Data presented by the firm shows the amount of people in the 55 and over bracket should probably keep rising, which should keep turnover-based equity extraction, and the resulting flow into bank deposits robust. This also suggests that bank deposit growth should be supported for at least the next few quarters, which should keep the bank appetite for MBS intact, Barclays researchers said.
They also noted that large banks have been strong buyers of MBS in 2006, with year-to-date net growth at $56 billion, according to data as of the end of April. The increased buying has been driven by heavy deposit growth as well as a dearth in alternative investments, researchers said. If bank deposits stop growing, it could lessen bank demand for MBS, thus eliminating an important marginal MBS buyer and hurting the basis, they said. While deposit growth was especially strong in 2004 and 2005, it has been slightly negative since the start of the year. Particularly concerning, analysts said, is the $50 billion drop in the last week of April. While the reasons behind this dip are not instantly apparent, analysts note that bank deposits were also volatile in 2004 and 2005, a period in which they rose by approximately $400 billion. Nevertheless, the recent drop makes this a good time to analyze prospects for bank deposits over the next few quarters, analysts stated.
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