Fed’s mortgage bond rescue could put some lenders out of business

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The Federal Reserve has begun purchasing hundreds of billions of dollars in bonds, including mortgage-backed securities (MBS), to help shore up debt markets. While the move has helped create liquidity in the market, it’s also had the unintended effect of creating more volatility in interest rates. Despite the Fed’s intentions, the net effect is that some lenders are now facing severe disruption, including potentially bankruptcy, if the market doesn’t settle down.

The Mortgage Bankers Association (MBA) sounded the alarm on the short-term effects to lenders, even as it supports the long-term purpose of the Fed’s plan to keep the market healthy.

The Fed’s unlimited purchases of Treasurys and MBS “should have the effect of greasing the wheels of the credit markets,” says Allen Price, senior vice president at BSI Financial Services, a loan servicer. “It adds sufficient liquidity in the marketplace which should provide stability in the markets.”

In the end, the Fed’s move should help borrowers, “since rates should be lower as the Fed continues to purchase MBS,” says Price.

Of course, to get to the long term, the market – and lenders – must first survive the short term.

Debt markets are volatile, causing uncertainty for lenders

The roiling debt markets have made life difficult for lenders. Mortgage rates are correlated with the 10-year Treasury, whose rate has bounced from an all-time low of 0.32 percent to more than 1.25 percent over the course of the last five weeks, sending mortgage rates up and down, too.

This volatility makes it hard for lenders to protect their mortgage investment. When lenders originate loans, they often hedge their position to protect its profitability. That is, they want to protect against a rising interest rate that would cause the mortgage to be worth less to them.

But when rates jump around due to skittish investors – or the Federal Reserve – buying and selling bonds, it becomes tough for lenders to make smart hedges. In many cases, the hedges that are meant to protect their profits are actually costing lenders even more money.

As the lender loses money on the hedge, the broker that sold the hedge notifies the lender that it needs to put up more money to hold the position, or what’s known as a margin call. If the lender can’t put up the money or interest rates continue to work against the hedge, the lender can be forced to liquidate its positions, declare a loss and close up shop.

“Margin calls on mortgage lenders reached staggering and unprecedented levels” at the end of March, said MBA CEO Robert Broeksmit in a letter to the Securities and Exchange Commission (SEC). “For a significant number of lenders, many of which are well-capitalized, these margin calls are eroding their working capital and threatening their ability to continue to operate.”

If these margin calls happen to enough lenders, it disrupts the ability of the mortgage market to offer loans and underwrite home purchases.

So the MBA has called on regulatory authorities such as the SEC and the Financial Industry Regulatory Authority (FINRA) to issue guidance to brokers on how to issue margin calls so that they don’t destabilize the market. Otherwise, the MBA warns that “the U.S. housing market is in danger of large-scale disruption.”

And with the problems caused to the U.S. economy due to the novel coronavirus, investors and homebuyers should expect the Fed to maintain its intervention, helping to support markets.

“The Fed is working with lenders and should continue to do so, particularly since the pandemic issue may become a protracted global issue,” says Price.

While the Fed’s support ultimately will help markets, mortgage lenders may have to suffer more in the short term.

What mortgage shoppers, refinancers should know

In response to the rate volatility, some lenders are sharply curbing how long they’ll lock your rate. Lenders may cut their lock down to as little as two weeks, meaning homebuyers have less protection against swings in rates. While finding a low rate is a key part of mortgage shopping, it’s less valuable if you can’t actually lock that rate and ensure you get it. So homebuyers should find lenders that give them enough time to lock the rate and close the deal.

Refinancings can still happen in 30 days or less in many areas, but a purchase mortgage might take 60 to 90 days or more to close. Try to lock for at least that long.

This means that consumers may have to spend more time looking for a lender that meets their needs. And with all the volatility, as well as record demand for mortgages due to low rates and the effects of the coronavirus, consumers should expect delays at almost every step of the process.

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Written by
James Royal
Senior investing and wealth management reporter
Bankrate senior reporter James F. Royal, Ph.D., covers investing and wealth management. His work has been cited by CNBC, the Washington Post, The New York Times and more.
Edited by
Senior mortgage editor
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