The year 2013 could bring changes within the interest rate environment. While it is highly likely that interest rates will remain relatively low, even a small but sustained rise in rates could affect origination levels. Recent surveys indicate that a 50-basis point rise in rates, if sustained, could reduce production by about 30 percent. The Fed has indicated that it will keep rates low until 2015, yet there are many contributing factors that could cause some bumps in the road for mortgage interest rates.
For mortgage companies to be able to withstand the effects of that happening, they need to ensure that their business plan resembles that of a “superstar” CEO, the type of leader who looks beyond current issues and accordingly fortifies his or her organization so it can withstand market shifts.
To develop this kind of vision, mortgage strategists should first consider some of the factors behind today’s historically low rates:
► The Fed is purchasing mortgage-backed securities (MBS).
► The economy, while showing signs of recovery, continues to struggle.
► The “Fiscal Cliff” debates continue, threatening another U.S. recession if unresolved.
► Geopolitical uncertainties remain a wild card.
This confluence of factors has led to a perfect storm making interest rates attractive. While rates may remain low for another year, the bond markets may eventually not like what they see from any of these issues.
Expanding regulations, increasing deficit
The Consumer Finance Protection Bureau (CFPB) will play a larger role in many organizations with increased regulatory oversight. As a mortgage professional, here are the questions you need to ask: Is my company prepared for more CFPB oversight? What steps are we taking in anticipation of such changes? Is our legal department adequately staffed to address the increase in review and input required? Is our company prepared for the enormous cost of compliance?
The economic challenges affecting the mortgage industry include the aforementioned fiscal cliff. Although an unresolved fiscal cliff can be a short-term plus for the interest rate environment, a long-term lack of resolution would be negative. Conversely, should the fiscal cliff be averted, there is a strong possibility that a stock market rally will ensue with a sell-off in the bond market to provide the cash to fuel it. This could result in rising rates.
Additionally, it is highly likely the deficit will continue to grow. Currently, the amount of deficit spending stands at approximately 43 percent. This means that for every $100 that the United States government spends, $57 is collected from revenue and the remaining $43 must be borrowed. As of now, the government is able to borrow that money at a very low rate on open markets—and the bond market continues to support that. In fact, the United States is providing those funds. The Federal Reserve has been buying a great deal of those Treasury bonds; 61 percent during the past year. This concerns a lot of people because the Fed’s balance sheet is becoming bloated.
Foreshadowing the “Bang Moment”
There is only so much that we can add to the Fed’s balance sheet before the bond market becomes concerned. The U.S. credit rating has already been downgraded. As previously mentioned, the current deficit spends stand at 43 percent—and is growing. Traditionally, the bond market says “no more” when the deficit spending rises 50 to 65 percent. This is known as the “Bang Moment,” the moment that causes interest rates to rise dramatically over a short period of time. We have seen this time and again throughout history, but most recently in countries like Greece, Spain, Portugal and Italy.
In one year, Greece saw interest rates rise on a 10-year bond note from six percent to 30 percent. Portugal saw interest rates on their 10-year bond go from four percent to 12 percent—again, all in one year. Spain went from three percent to more than seven percent; now the rate is at six percent. If the U.S. continues the need to borrow, we will have to pay higher rates. This means the return on bond investments will decline, which may lead to an increase in mortgage interest rates.
The bond market in the U.S. will likely allow our country the better part of 2013 to get on the right track. But it if becomes apparent that little to no progress is being made and the U.S. Debt situation continues to worsen, there could be a rapid change in interest rates. Mortgage companies, mortgage professionals and consumers have become accustomed to low rates. However, those low interest rates will not—and cannot—last forever.
Hedging for change
How are superstar CEOs planning for this “Bang Moment?” They are hedging. Think about it. As human beings, we hedge everyday by preparing for life events. For example, what happens if we get into a car accident? We have auto insurance. What happens if we get sick? We have medical insurance. What happens, heaven forbid, if we die? We hedge against that by trying to minimize financial distress with life insurance. Consequently, although we hedge in our everyday lives, we often don’t hedge in our business behaviors.
If interest rates decline, we should expect business opportunity to rise, and we should be prepared to handle that influx of transactions. In addition, our marketing efforts need to be at their best so we can reach out and capture possible clients while the opportunity is ripe. On the other hand, what if rates rise? In that case, we need to hedge within our business by developing relationships and capturing more leads from real estate agents, attorneys and accountants, whose leads are less sensitive to interest rates when compared to refinance opportunities.
More importantly, mortgage professionals need to hedge their individual finances. When you ask a mortgage professional where he or she has invested his or her own money, many say, “Well, I’m conservative, and my assets are in bonds.” While that might be a good idea for someone who is not in the mortgage business, a person who is already in the industry has a high stake in the mortgage bond market. This is because improving bond prices means improving business conditions, while adverse bond market conditions most likely results in adverse business conditions. By adding their personal portfolio to the mix, mortgage professionals are at risk of putting all, or certainly most, of their “eggs” in one “basket.”
Instead, it might be wise to structure your portfolio so that you can personally profit when interest rates rise. As a savvy mortgage professional, you should look to leverage that situation with some of your personal investments. Your financial advisor can easily direct you to the many tools that can accomplish this goal.
Planning like a superstar
In conclusion, if 2013 is indeed to be a year of great change, you need to prepare for it just like the superstar CEOs would. Successful mortgage professionals look at the right and left tail of the bell curve and plan for both. They examine the current environment, and they project going forward. I have learned one thing: There is only one thing that does not change, and that is change itself. If we know things will change, why assume the current rate environment will remain the same? That is like driving by looking in a rear view mirror. Unfortunately, it seems that’s how some people run their businesses.
So ask yourself: What is the most likely outcome? Then plan and hedge for the right and left tail risk. This means looking at a very favorable outcome for the industry and determining how to maximize that, while also planning for the very negative outcome, which would be interest rates increasing significantly. Then ask yourself: Am I prepared for that, both with my business and my personal portfolio? If there are more regulations, do I have the staff needed, as well as the right business model? These are the things that the smart superstar CEO will be focused on in order to succeed in 2013.
Barry Habib is chief market strategist for Residential Finance Corporation (RFC). Before joining RFC, Barry was the founder, creator and CEO of Mortgage Market Guide, which helps to interpret and forecast activity in the mortgage rate and bond markets. Barry has also enjoyed a long tenure as a market expert on FOX and CNBC Networks, including his Monthly Mortgage Report, which can be seen on Squawk Box. Follow him on Twitter @barryhabib.