Volatility Returns within the Mortgage Market

Last weekend, I spent some time on the wholesale channel of the annual National Association of Mortgage Brokers in Las Vegas. Click here for my PPTX slides. The good news is that the prepayment speed for all major MBS product types increased month by month in September. Freddie Mac speeds showed the biggest increase.

The bad news is that wholesalers pretty much cut their margins to break even in response to falling volumes. Kind Lending founder Gary Stearns told the NAMB audience that when the wholesale channel slows down, it always feels the pain first, and that after a remarkable run, the industry changes.

When it comes to profit margins and visibility of future volumes, winter is back for the mortgage industry. The remarkable and profitable spring for 1-4s in 2020 is being replaced with something that looks very much like 2019. That doesn't mean the mortgage market is done with this bull cycle, far from it. But it means preparing for a market without the Fed as the biggest buyer.

The Fed's total purchase of mortgage-backed securities last week was $ 5.4 billion, according to the New York Fed, compared to $ 4.9 billion in the previous session. “The trading volume in the UMBS 30-year stack was positive across all coupons. UMBS coupons of 4 percent were the most prominent at + 241%, 2s saw the most bonds that changed hands at around 35 billion US dollars, ”reports Bloomberg.

The volume in TBAs rose 64% above its last average, while the 30 year UMBS volume was + 98% and the 30 year Ginnie Mae II volume was around + 2%. Hardly a bad performance in any way. But when we arrived last Friday, the mailbox was filled with messages from lock counters about price adjustments for future deliveries. Market volatility will also be back in effect at the end of 2021, for both credit pricing and stock valuations.

Some of the independent mortgage lenders that managed to go public at that time a year ago when the volume peaked over $ 500 billion in November are being hit pretty hard. United Wholesale Mortgage and industry data duo Black Knight are the worst performers after the GSEs, Fannie Mae and Freddie Mac.

Even solid companies like Penny Mac and Guild Mortgage don't get any respect in the stock market. But on the other hand, Mr. Cooper, New Residential and Chimera, along with several mortgage lenders, are leading up the group of mainly REITs.

Flagstar Bancorp, which is about to merge with New York Community Bank, is one of the top performing mortgage specialty custodians this year. At the top of the list, however, is Western Alliance Bancshares, which Amerihome acquired from Athene earlier this year. As one of the better bank names among all US banks in 2021, Western Alliance is up nearly 90% in 2021.

All the better names in the mortgage sector are backed by a community of investors who are used to ever higher stock prices and make price corrections fast and steep. It is worth mentioning the brisk business in the non-agency lending business, a marginal market that is growing rapidly above the agency and banking markets, but can withdraw even more quickly.

As the mainstream mortgage business shifted from a focus on government lending in 2020 to conventional this year, the same appreciation in home prices has driven the non-QM lending market into a buying frenzy. Over a dozen non-QM lenders were represented at the NAMB conference, competing for a relatively small market for non-agency loans. Investors even get FHA loans at premium rates.

Admittedly, people don't do well in crowds when it comes to investment decisions or life in general. Buying mortgage-related assets is no exception. A year ago there was some value to be had in loans and related assets, but today the execution is way above fair value. The returns for conventional servicing in the late vintage, for example 5-6x multiples, look decidedly negative during the cycle. Many investors do not appreciate this little nuance.

The big question on the mind of mortgage bankers is how the Fed reducing, or even stopping, MBS purchases will affect mortgage rates. Stan Middleman, founder and CEO of Freedom Mortgage, told me in an interview last week that weak employment data and investor demand will keep rates low even if the Fed stops buying MBS for the next six months.

While many observers wonder when and how house prices are likely to correct, the reality of investor demand for assets is unlikely anytime soon. For this reason, the FOMC should deliberately pursue its stated plan to end the MBS purchases. Instead, the Fed will focus its open market purchases on Treasury bills and coupons in order to maintain the central bank's total assets.

As the mortgage market digests Washington's federal budget advances, be on the lookout for greater volatility in the financial markets. Uncertainty about the economy, which is likely to keep borrowing costs down, should also cause considerable excitement for investors if the endless surge in asset valuations slows or reverses. This market does not tolerate negative returns, even for a short time.

The impact of the Fed's discontinuation of direct purchases of MBS may be dampened by secular demand for assets of all kinds, but the short-term response to actual changes could be important to IMBs and consumers alike. In the meantime, look for the smarter operators in the industry who take money off the table even when investors rush to buy loans and service assets at prices that can ultimately result in significant capital losses. But we've already seen this film.

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