The Perfect Storm

Understanding the current market

Insider

Chief Operations Officer, Atlantic Bay Mortgage

As we near Q4 of 2022, many of us find ourselves in what feels like the perfect storm. Those of you that are busy navigating the various challenges understand that it is coming from many directions, all at once. However, for those of you that are laser focused on your respective area, with minimal insight into the larger picture, you may be sitting with a lot of confusion or unknowns. So, what is going on? Is your company alone in their challenges?

To give insight into what is going on now, we need to dial it back to Q1 2020. Mortgages were in what some called the ultimate trifecta: Low interest rates, lowest unemployment rate and highest equity positions. As we all know the pandemic changed everything. A lot of what was happening behind the scenes with margin calls, investors pulling out of various products and programs was a direct result of the unknown. Would defaults mimic 2008? Would unemployment go through the roof? Would businesses shut down? As we know, the market doesn’t respond well when they are unable to make an educated prediction to the near future. Mortgage-Backed Securities were not a “hot commodity” on the secondary market. I mean who wishes they were an investor in 2008? So, what ultimately happened? The government stepped in and became the number one purchaser of MBS. This is called Quantitative Easing. Here is where we saw the rates really decrease. As we all know this was artificially stimulated by the U.S. government.

So, why does that matter to what we are experiencing now? Well, in the most simplistic explanation, the government stopped buying MBS’ and raised Federal Funds rates. This is what you call Quantitative Tightening. That is where you started to see that massive rate hike that felt like it was overnight. Rates being high is only one battle that we are facing in this “storm.” Life will move on at any interest rate, as history has shown us time and time again.

Another challenge we are facing as an industry is simply in the fact that the volatility in the market is still there. Between inflation, fear of a recession and the unknown of whether rates will rise or fall, cause investors in the secondary market to take a conservative approach towards buying Mortgage Back Securities.

This issue, paired with the reduction in volume, has caused the spread between revenue and expenses (what a company must make to stay open and profitable) to be reduced dramatically. Therefore, we have seen so many layoffs across the industry. Everyone is affected by the price tag (or lack thereof) of the MBS’.

An interesting result of these market dynamics is that lenders (large and small) may begin to exit sectors of the market and sometimes altogether. This inadvertently affects many lenders and causes a domino effect. I was amazed to learn how a large company finds themselves in an “overnight shutdown,” as we have seen with a couple of lenders in the last several months.

An interesting result of these market dynamics is that lenders (large and small) may begin to exit sectors of the market and sometimes altogether.

There are many factors that could lead to that decision. Some of which are the combination of running at a loss and the concern of the potential of a margin call on their MSR lines. Today, many companies are either making minimal profit or running at a loss, until they get their expenses in line with their new revenue margins.

A company’s servicing portfolio is one of their greatest assets, especially since it is currently packed full of low interest rate loans. A lot of companies are borrowing from their MSR asset (much like an equity line of credit on your house) and utilizing that to offset the losses.

The kicker is that most MSR lines do not allow you to borrow more than 60%(ish) AND the value of the asset that is collateralizing that MSR line changes, often. When the value drops (rates go down, etc.) and you might be over the max borrowing limit. The warehouse lenders then require you to pay it back down to your max loan to value. This is called a margin call. If you do not have the cash to pay it, you find yourself in a very difficult situation.

One of the outcomes might be to close your doors. Unfortunately, it doesn’t end there. Any lender that has taken out a best-efforts lock with that investor and is left “unhedged,” essentially must go to market with the loans that they have locked with said investor that no longer exists.

For example, I was talking to a lender the other day. They are a moderately sized shop at about $1.5B of closed volume a year. They had 22 loans locked with FGMC at the time their doors were closed. These loans were locked as Best Efforts and left unhedged, since the rates offered by FGMC weren’t offered with any other investor/agency. These were all agency qualified loans, closed/funded and cleared for purchase. Since they had to go to current market pricing on the Friday that FGMC closed, they lost $70,000. That is simply just from being unhedged and pricing at market.

As an industry, we are also seeing an uptick in repurchases, refusal to purchase, recourse and other negative post-close events. Most companies experience those events in a normal market, cost of doing business. In those cases, an IMB must sell those loans on the Scratch and Dent market. Typically, a scratch-and-dent bid pays $.90 to $.95 on the dollar. In this market, they are paying $.60 to $.80 on the dollar. That is a substantial loss.

There are many more factors at play, but overall, these are the highlights. Every lender I speak to has stated they are seeing a decrease in quality (which is most likely attributed to their staff being slow and not fully focused on what they are doing), an uptick in back-end requests, a struggle to keep expenses in line with profit, the desire to offer every product and program to be competitive yet weighing the risk of being stuck with those loans at a 20-40% loss. If you are feeling like this is a company problem, rest assured you are not alone.

The good news is this business is cyclical. We will come through the storm, like we always do. The instability will calm down and life in mortgages will, yet again, settle into our new normal. Until then, I really encourage everyone to lean on their peers. It is helpful to be reminded that others are experiencing the same challenges as you are. Hey, they may even have some creative solutions that could help.