Is it time for IMBs to cash in their chips? – National Mortgage News - 24line

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الأحد، 23 أكتوبر 2022

Is it time for IMBs to cash in their chips? – National Mortgage News

On Sunday, the Mortgage Banker’s Association convened its annual conference in Nashville. Lenders and servicers confront rising interest rates and increased capital requirements from regulators — this in response to market risk unleashed by the Federal Open Market Committee. The Washington solution to growing risk? Industry consolidation to separate the weak from the strong among small depositories and independent mortgage banks.

A decade and more since the Great Financial Crisis, the mortgage industry continues to adjust capital, risk profiles and business models. Creating and selling 30-year residential mortgages (with free, in-the-money prepayment option attached) is in many respects an act of madness. But even worse is the idea that IMBs are somehow the problem in residential lending.

Fed Chairman Paul Volcker wiped out the lightly capitalized Savings and Loans in the 1980s by pushing interest rates above the funding costs. Many thrifts did not have federal deposit insurance and failed in droves. And yet it was nonbank lenders that actually came to the rescue of Ginnie Mae when the S&Ls were annihilated by double digit interest rates four decades ago.

“During the late 1980s S&L crisis, IMBs bailed out Ginnie Mae by buying mortgage servicing rights from failed S&Ls and the RTC,” recalls David C. Stephens, Chief Operating Officer of United Capital Markets. “Other IMBs, as master servicers, recovered Ginnie Mae MSRs from failing S&Ls, before RTC liquidation.”

“IMBs built Ginnie Mae,” Stephens continues. “Lomas Mortgage issued the very first Ginnie Mae security. Kisslack and other non-banks were the primary issuers of Ginnie Mae securities for many years. More recently, banks were scared out of the space by the misuse of the “False Claims Act” and other prosecutorial abuses out of the DOJ under President Barack Obama. They’re still afraid to move back into the market because the abuses have not been remedied.”

The wrongs of the past still linger in the minds of many mortgage lenders, but today such thoughts are a blissful distraction compared to the prospect of a market that seems headed to double digit coupons for well-underwritten mortgage loans by Q1 of 2023.  Double digit loan coupons? Let’s do the math. 

The yield on the Fannie Mae MBS for November delivery is ~ 6.4%. Add 1.75% for the spread of the MBS over the blended 5-10 year Treasury yield gets us over 8% for breakeven on the secondary market sale of the loan. That’s today.  The MBS created a year-ago trade against the blended 10-15 year yield BTW, if and when they trade.

If the FOMC does two more rate hikes of 75 basis points this year, then pauses, figure the new issue agency MBS yield goes into the 8% range and that means loan coupons in the 9s or 10s for average conventional loans — assets with 720 FICOs and 80 loan-to-value ratios. Weaker borrowers will be well into double digit loan coupons in conventionals and bank loans. 

As this writer noted in a missive about mark-to-market losses caused by rising interest rates (“Will the FOMC Break the Financials?“), the relentless rise in benchmark yields has put a lot of older loans and securities underwater, so much so that these government insured MBS are now quoted like distressed assets on a discount price instead of a yield.

There are literally hundreds of billions of dollars’ worth of government insured loans and securities created during 2020-2021 that are fifteen, twenty or more points below the original issue price.  For this reason, dozens of depositories are now technically insolvent and will lose access to bank funding and the Federal Home Loan Banks without waivers from federal regulators. 

Granting waivers to insolvent banks assumes that the deficit in “accumulated other comprehensive income” or negative AOCI is eventually reversed. But maybe not. What happens if those Fannie, Freddie and Ginnie Mae 1.5s and 2s never come back into the money?  

COVID-era loans and securities constitute a low-coupon ghetto that TBA traders avoid because of the high price volatility. JPMorgan, Bank of America and Wells Fargo together had almost $50 billion in negative AOCI marks on their available for sale portfolios in Q3 2022. The negative mark for the industry on the $3.2 trillion in bank-owned MBS could be in the hundreds of billions of dollars. 

Banks and IMBs alike are sitting on servicing portfolios comprised of loans that may not be in the money for refinance for many years to come. This creates a profound dilemma because the related MSRs owned by these firms now bear premium valuations that are dependent, in part, on the future potential to refinance the loan. Without new lending and recapture of portfolio assets, present fair values for MSRs come into question.

Moreover, more aggressive issuers levered the MSR as it rose in value in order to raise cash. The magnitude of the increase in interest rates since the start of 2022 is far larger than the decline in rates in 2020-2021, leading to the obvious question: where will the cash come for future margin calls on MSR financing as and when interest rates eventually fall?  And the loans behind these MSRs may not be in the money for refinance for years to come, if ever.

Even if the FOMC does pause rate hikes at the end of 2022, putting the federal funds rate around 5%, that leaves the financial community with a pile of market risk embedded in portfolios due to market volatility.  Now you know why all of the regulators, from the Fed and OCC for the banks, to the Federal Housing Finance Agency and Ginnie Mae, are all pressing Jamie Dimon at JPM and other banks and IMBs to raise more capital. 

The movement of interest rates determines the balance when it comes to market risk and, by connection, the credit risk the bank takes in lending against a pool of fixed-coupon mortgage loans. And IMBs take nowhere near as much market or credit risk as the depositories that actually fund the mortgage business.

When it comes to mortgage market risk, being a bank is actually worse than being an IMB. Banks operate at 15:1 leverage. IMBs 2-3 times leverage. Every dollar of loss at a bank eats more capital, whether from credit loss or market risk. This is why banks need 10% or more capital to assets and federal deposit insurance. Yet simply having capital is insufficient without good controls on market and interest rate risk.

“IMBs have nowhere near as much leverage as banks,” Stephens of United Capital Markets told NMN. To say that Basel III is a good match for the risk of IMBs owning MSRs is totally at odds with the public record. You cannot justify at 250% risk weighting with any prior loss experience with an IMB. Without a strong market for released and retained MSRs, there would be no GNMA originations.”

As the MBA meets in Nashville, many IMBs will be looking for buyers or wondering whether to turn off the lights entirely and go home. Many yield hungry depositories, on the other hand, will be salivating over those rising loan coupons and wondering how to get a taste of the gate to make up for unrealized losses in portfolio.  And everybody in the financial world is wondering how to survive the tsunami of market risk caused by the highest mortgage interest rates in twenty years.

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