(The following is a summary of a much longer article published
on March 26, 2020 by Barry Habib, President of MBS Highway.)
The COVID-19 Crisis has been wreaking havoc with the economy and society at large. The impact to the mortgage industry has been equally damaging.
The Corona-Crisis has negatively impacted the mortgage industry on a number of fronts:
The Servicer Dilemma:
Mortgage borrowers make their monthly payments to their Loan Servicer. This servicer may or may not be the same lender they obtained their mortgage from. If you’ve ever been informed by your lender that your loan was being transferred and going forward you should send your payments to another company, then you know what I’m talking about. When a mortgage is transferred to a new servicer, it typically takes that servicer about three years to recapture their costs of obtaining the loan. The longer that loan remains on their books, the more money that servicer makes.
However, when rates drop, many people refinance their mortgages and the servicer of their original mortgage is paid off. This “Servicing Runoff” creates losses for the mortgage lender that is servicing the loan. Yet at the same time, these lenders typically experience an increase in new loan activity because of the decline in interest rates. This typically gives them additional income to help overcome the losses in their servicing portfolio.
Unfortunately, the Coronavirus has created a virtual shutdown of the US economy which is creating unprecedented job losses. This adds a new risk to the servicer because borrowers may have difficulty making their mortgage payments. And while the servicer does not own the loan, they are responsible to make payments to the investor who does, regardless of whether the borrower is making payments. The fact that the government is promising to allow adversely affected borrowers to postpone mortgages payments is only exacerbating this problem. Under normal circumstances, servicers have cushion to account for this. However, extreme levels of delinquency put these servicers in a precarious position.
The overwhelming number of payoffs caused by the unprecedented increase in new mortgage volume has slashed the value of these servicer’s portfolios almost in half. Since many servicers finance the acquisition of a large portion of these portfolios, they’re experiencing margin calls. Additionally, the decreased value of a Lender’s servicing portfolio reduces the Lender’s overall net worth. Since the amount a lender can lend is based on a multiple of their net worth, the decrease in value of their servicing portfolio asset, along with the cash paid for margin calls, reduces their capacity to lend.
The Fed’s desire to bring down mortgage rates isn’t just damaging servicing portfolios because of prepayments, it’s also wreaking chaos in lenders’ ability to hedge their risk.
In an effort to reduce mortgage rates, in recent days, the Fed has been purchasing an incredible amount of Mortgage Backed Securities, causing MBS prices to rise dramatically and swiftly. This, in turn, causes the lenders’ hedged short positions of MBS to show huge losses. These losses appear to be offset on paper by the potential market gains on the loans that the lender hopes to close in the future. But lenders’ broker dealers will not wait on the possibility of future loans closing and demand an immediate margin call. The recent amount lenders are paying in margin calls is staggering, running into the tens of millions. So, while the Fed believes they are stimulating lending, their actions are resulting in the exact opposite.
Furthering the Fed’s unintended consequences was the announcement to cut interest rates on the Fed Funds Rate by 1% to virtually zero. Because the Fed’s communication failed to educate the general public that the Fed Funds Rate is very different than mortgage rates, it prompted an even larger influx of potential mortgage borrowers thinking they could lock a mortgage rate close to 0%. This increase in volume further strained the system.
The current mortgage market is experiencing a perfect storm scenario. Just when volume levels were at the highest in history, servicing runoff at its peak, and pipelines hedged more than ever, the Coronavirus arrived. In order to mitigate losses and clear out bloated pipelines, lenders across the country have increased pricing despite Mortgage-Backed-Securities being at all-time highs which would normally result in mortgage rates being at all-time lows.
While this crisis continues to evolve, the silver lining is that every day we all get closer to it ending. There is a light at the end of this tunnel. We all must remain faithful that the effects of the Coronavirus will subside and that things will become more normalized in the upcoming months.
Warren Goldberg is President of Mortgage Wealth Advisors, a Certified Mortgage Planning Specialist®, and a published author. His interviews include Blog-Talk Radio, Newsday, The Daily News, Anton Press, and the Long Island Herald. Since 1992, he’s been sharing his financial knowledge and wealth-building strategies, including how to properly use your mortgage as a financial tool. His clients regularly express their trust and appreciation by recommending friends and family call when in need of mortgage, real estate, and financial guidance.
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