Mortgage industry executives are on alert amid concerns about a global stock market crash. United States Federal Reserve The federal funds rate could remain too high for an extended period of time, which could tip the U.S. economy into recession.
Tensions in the bond market have led to lower mortgage rates, which is good news for originators because they are likely to have more demand for their loans. Operationally, leaders must decide when to add capacity (if not already) and how to manage incoming volumes. They will also monitor early payoff (EPO), which is a fee charged by the investor each time the borrower pays off the mortgage, usually within six months of financing.
When considering the servicing business, a sharp decline in interest rates can reduce the fair value of mortgage servicing rights (MSRs), which could impact a lender’s earnings if the lender does not protect its portfolio from these changes. If the answer is no, there’s a caveat: During periods of volatility, hedging costs can rise.
The market turmoil began after a jobs report released on Friday showed that the unemployment rate in July was 4.3%, up from 4.1% the previous month, while total non-agricultural employment increased by 114,000, which was lower than analysts expected.
Investors began selling, causing the two-year note yield to fall from 4.12% on Friday to a low of 3.87% on Monday, above the 10-year note’s low of 3.66%. When the curve inverts, short-term yields are higher, which is a sign of recession. Bond yields partially recovered on Tuesday, with the two-year note yield at 3.93% and the 10-year note yield at 3.83%.
Melissa Cohn, Regional Vice President William Lavis MortgageIt said the market was reacting to weaker-than-expected economic reports that suggested the U.S. could slip into recession. This means that Fed officials should cut interest rates at their July meeting. Geopolitical realities such as tensions in the Middle East only exacerbate volatility.
“If you look at the jobs report and this trend continues for another month or two, the answer is yes: the economy is going to be in recession,” Cohen said. “Is the Fed going to make an emergency rate cut? I don’t know. I don’t think we’re there yet. We’re going to have a few days of extreme volatility. We’re going to be on a roller coaster, but we’re not off the cliff yet.
In the mortgage market, Cohen said this was reflected in the fact that mortgage rates for borrowers with good credit fell to the “high 5” on Friday and rebounded to the “low 6” on Monday. She added that conforming loans “have seen much steeper declines than the large-loan segment, with some banks cautiously lowering rates.” Meanwhile, rates in the nonconforming mortgage business have “fallen more slowly.”
Get ready for lower interest rates
William Chang, Senior Managing Director and Chief Investment Officer Pennymark, On Monday morning, “stock and bond markets opened with wild swings as investors rushed to safety and piled into U.S. Treasuries.”
“Mortgages were not performing well throughout Monday morning, but the market seemed to stabilize a bit in the afternoon,” Zhang added, largely because of data showing the services sector expanded in July.
“If Treasury yields do continue to fall, you’re going to see originators bring back some capacity,” he said. “It just depends on how quickly that happens. If interest rates fall significantly, the refinancing bubble market will suddenly grow, but if If interest rates rise in steps, then the refinancing bubble market will be more gradual and people will be able to adjust their capabilities accordingly.
Zhang said major moves to introduce more refinancing operations to the market will “lay the foundation for potentially better profit margins” as some companies will experience capacity shortages. At that time, the originator will give the borrower a longer lock-in period. Some lenders will wait to add capacity, but others may feel the need to hire local liaisons.
Industry executives say the early returns are a side effect of the refinancing wave, but the market has yet to notice the impact due to recent declines in mortgage rates. Another impact of lower interest rates is on the service mix, which is a decrease in the fair value of the MSR. Lenders protect their balance sheets by offsetting their books.
“We want to help preserve our book value and minimize earnings volatility. But we also borrow against the MSR, so if, for example, we get a margin call, we do want to have hedge earnings that we can leverage earnings to help offset fair value declines and help us meet these margin calls if necessary,” Zhang said.
Chang said Pennymac would consider “basically 125 basis points on the upside and 125 basis points on the downside” when planning hedging positions. He added that the company “entered this period of market volatility with optional coverage,” but if “we bought more options now, it would be very expensive.”
exist United Wholesale Mortgage CompanyChief strategy officer Alex Elezaj said sales have increased over the past few days due to lower rates, and the company expects this to continue through the end of the year.
“People have locked in on Band 5-plus loans over the past few days because there are millions of consumers with mortgage rates in Band 6, 7 or 8,” Elezaj said. “Historically, as interest rates come down, Margins generally expand – but I think it’s hard to say, especially since this has only been happening for a few days and the dust needs to settle before people get excited in some way.
Elezaj said UWM has invested in technology, hired people and improved processes so brokers can close loans within 14 days without extending the borrower’s lockout period. When the refinancing wave hit, he said the EPO was a “good problem”, meaning “it’s part of doing business”.
UWM has taken a different approach than other competitors by focusing on the origination business by selling MSRs. Elezaj said loan production is like a “natural hedge” for the servicing mix.
