This past weekend, I spent some quality time in the wholesale channel at the National Association of Mortgage Brokers annual in Las Vegas.
The bad news is that wholesalers have cut margins pretty much to break even in response to falling volumes. Kind Lending founder Gary Stearns told the NAMB audience that the wholesale channel always feels the pain first in a slowdown and that changes were coming to the industry after a remarkable run.
When it comes to profit margins and visibility on future volumes, winter is here once again for the mortgage industry. The remarkable and profitable springtime for 1-4s in 2020 is being replaced by something that looks a lot like 2019. That does not mean that the mortgage market is done with this bull cycle, not by a long shot. But it does mean preparing for a market without the Fed as the largest buyer.
The Fed’s aggregate buying of mortgage-backed securities last week was $5.4 billion, compared to $4.9 billion the prior session, according to the New York Fed. “Trading volume in the UMBS 30-year stack was in positive territory across all coupons. UMBS 4 percent coupons were the most ahead at +241%, 2s saw the most bonds change hands at about $35 billion,” Bloomberg reports.
Volume in TBAs was up 64% ahead of its trailing average, while UMBS 30-year volume came in at +98%, Ginnie Mae II 30- year at around +2%. Hardly a bad showing by any measure. Yet, as we went into last Friday, the mailbox was filling up with notices from lock desks about repricing for future delivery. Market volatility is also back, in force, as 2021 ends, both for pricing loans and equity valuations.
Some of the independent mortgage banks that managed to go public this time a year ago, when volumes peaked over $500 billion in November, are getting beaten up pretty badly. United Wholesale Mortgage and industry data duopoly Black Knight are the worst performers after the GSEs, Fannie Mae and Freddie Mac.
Even solid businesses like Penny Mac and Guild Mortgage are getting no respect in the equity market. But Mr. Cooper, New Residential and Chimera, on the flip side, are leading the group of mostly REITs higher, along with several mortgage banks.
Flagstar Bancorp, which is in the process of merging with New York Community Bank, is one of the best- performing mortgage specialty depositories this year. Top of the list, however, is Western Alliance Bancshares, which
All of the better names in the mortgage sector are supported by an investor community that is accustomed to ever higher stock prices, making price corrections swift and steep. One indicator that deserves mention is the brisk business being done in the world of non-agency lending, a fringe market that grows quickly atop the agency and bank markets, but can retreat even faster.
As the mainstream mortgage business has migrated from a focus on government loans in 2020 to conventionals this year, the same home price appreciation has driven the market for non-QM loans into a buying craze. The NAMB conference featured representation from over a dozen non-QM lenders, who are competing for a relatively small market of non-agency loans. Investors are even scooping up FHA loans are premium prices.
Humans admittedly do not perform well in crowds when it comes to making 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 servicing assets, but today execution is well above fair value. Returns on late- vintage conventional servicing, for example, at 5-6x multiples are looking decidedly negative through the cycle. Many investors don’t appreciate this little nuance.
The big question on the minds of mortgage bankers is how the reduction or even cessation of MBS purchases by the Fed will impact 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 ends purchases of MBS over the next six months.
While many observers wonder when and how home prices are likely to correct, the reality is that investor demand for assets is unlikely to cool anytime soon. This is why the FOMC should deliberately move ahead with its stated plan to end MBS purchases. Instead, the Fed will focus open market purchases on Treasury bills and coupons to maintain the size of the central bank’s balance sheet.
As the mortgage market digests the progress in Washington on a federal budget, look for greater volatility in the financial markets. The uncertainty about the economy that is likely to keep borrowing costs low is also likely to cause investors considerable agitation when the endless upward climb in asset valuations slows or reverses. This market has no tolerance for negative returns, even for a short period of time.
The impact of the Fed ending direct purchases of MBS may be muted by secular demand for assets of any description, but the short-term reaction to actual changes could be significant for IMBs and consumers alike. In the meantime, look for the smarter operators in the industry to take money off the table even as investors rush in to buy loans and servicing assets at prices that may ultimately generate significant capital losses. But we’ve seen this movie before.
