While winter storms range around the United States, and George Bush is delivering pizza to his unpaid secret service detail, we enter the Martin Luther King Day weekend with a lot going on in residential lending.
Sure long term rates have moved down, and more or less stayed there, leading to murmurings of more refis. Indeed, LOs are seeing plenty of borrowers whose HELOC rates have moved up, their tax deductibility problematic, and where it actually makes sense to refi. The move up in short-term rates, and the stability or reduction in long-term rates, has dampened the demand for adjustable rate mortgages in the primary market. In fact, in some scenarios the price of a 7/1 ARM is worse than a 30-year fixed. But there are plenty of existing loans and securities tied to LIBOR/Libor. What’s the latest on the transition away from using Libor? Don’t shrug and say, “Our mortgage vendors will take care of everything for transitioning from LIBOR to SOFR.”
Recall that the validity and accuracy of LIBOR is suspect after an investigation showed price fixing.
Despite ICE’s best efforts, the transition away from the London Interbank Offered Rate (LIBOR) as the standard reference rate is moving forward. It is estimated $200 trillion of financial contracts and securities ($190 trillion in derivatives; $10 trillion in corporate bonds, mortgages, securitized products, credit card receivables, etc.) are tied to LIBOR, being used by small businesses, corporations, banks, broker- dealers, consumers and investors as a benchmark for short-term interest rates. In response to concerns regarding the reliability and robustness of LIBOR and other reference rates across the globe, the Financial Stability Board (FSB), as established by the G20, and Financial Stability Oversight Council (FSOC) called for the development of alternative risk-free benchmark interest rates supported by liquid, observable markets.
In the U.S. in 2014, the Board of Governors of the Federal Reserve System and the New York Fed established the Alternative Reference Rates Committee (ARRC), which eventually selected the Secured Overnight Financing Rate (SOFR) as the recommended alternative reference rate for the U.S. LIBOR is based on thinner markets and is not fully transaction based – the most active tenor (three months) posts less than $1 billion transactions per day – and submitted rates typically include expert judgement from market participants when determining the rate. SOFR, however, is based on the overnight repo markets, with over $700 billion of transactions per day. It is fully transaction based and therefore regarded as more robust than LIBOR.
The ARRC will continue to lead the transition away from LIBOR. Its objectives include, among others: identifying best practices for alternative reference rates and contract robustness; making recommendations for developing an implementation plan for orderly transitions away from LIBOR on a voluntary basis; and working with market participants to encourage the development of sufficient liquidity in futures and swaps markets referencing the new rate.
While the ARC’s work in the U.S. is helpful, bank legal experts are concerned financial regulators in different countries may embrace inconsistent fallbacks to replace Libor. Uncertainty about Libor fallbacks is making it difficult for banks to plan and is prompting calls for a supranational approach.
Some 83% of firms with exposure to Libor have not renegotiated Libor-based contracts, while only 2% of firms have completed the switch, according to a survey by consultancy JCRA and law firm Travers Smith. If companies leave the task to the last minute, it “will create a significant issue of capacity as there is only a finite number of legal advisers with the expertise necessary to renegotiate these contracts”, says Joshua Roberts, JCRA’s lead adviser on benchmark reform.
Mortgage servicing is not the only concern. Many people in financial services have expressed unease that issuers of corporate debt haven’t been participating directly in decisions guiding Libor reform, but that is starting to change. More companies are asking banks for input on preparations for the transition, and fallback language in debt documents increasingly acknowledges the shift away from Libor.
Lenders need to be proactive and identify LIBOR exposure. From the halls of the MBA Dan Fichtler reports, “(We are) spending quite a bit of time on the transition away from LIBOR. On the residential policy side, MBA has a working group on the mortgage-related elements of the transition – this group is our main venue for all of our policy work on the issue. Aside from educating members, our main goal is to serve as a forum for establishing best practices and/or standardization for the industry. This will include discussions around criteria for choosing new benchmarks for future production, operational issues related to servicing legacy loans tied to LIBOR, new consumer and other disclosures, and changes to fallback language in contracts.
“Our expectation is that the GSEs will be spending more time in 2019 determining: 1) what they will accept in terms of future production; and 2) what benchmark(s) they will use for servicers of legacy loans tied to LIBOR. We hope to work with them on issues like potential changes in the note language and the developments of timelines and implementation instructions (a la the Single Security Playbook, for example).
The Swiss Financial Market Supervisory Authority has issued guidance on replacing Libor, warning that moving to alternative reference rates has legal, valuation and operational-readiness risks. FINMA says amending contracts that mature after 2021 “to include practicable fallback clauses could help minimize potential legal risks”.
Lenders continue to tweak adjustable-rate product. For example, loanDepot’s LIBOR 5/1 ARM caps for the Conforming and High Balance ARM – DU programs are changing from 5/2/5 to 2/2/5. This change represents a positive for Borrowers in an increasing rate environment. loanDepot has also expanded its CMT 5/1 ARM offering to include the FHA 203(K) Standard Program.
PUGS
The partial U.S. government shutdown continues, as of this writing. Politicians wrangle will millions of people relying on government paychecks suffer. Bob Broeksmit, president and CEO of the MBA, writes, “The Washington Post had a surprising angle on the IRS restarting its fulfillment of tax return transcript requests (form 4506T), but I can’t help but wonder how the press would be reporting if we had not advocated this resumption on behalf of borrowers closing on purchase loans or taking advantage of the drop in interest rates to refinance their home mortgages. As with the resumption of flood insurance policy issuance and the announcement by the GSEs that servicers need not report to the bureaus when they make accommodations for workers affected by the shutdown, we will continue to advocate vigorously for homebuyers, homeowners, and federal employees impacted by the shutdown.”
William Taylor with Mortgage Factory Inc., dba Mortgages Direct, telegraphed, “Heartening to learn that uscurrency.gov has been spending money developing a mobile app that allows users to, “team up with Buck the Time-Traveling Dog on a quest through the historical events illustrated on the back of U.S. currency.’ Our tax dollars hard at work.”
US markets have been relatively untroubled by the partial government shutdown, having gained 4% overall since it began, and taxpayers have been told the Internal Revenue Service will likely issue their refunds, writes Ben Walsh. However, the White House has doubled its estimate of the possible effect on GDP and experts including JPMorgan Chase CEO Jamie Dimon have issued warnings on that aspect, while Walsh points out the airline industry could be particularly affected if the impasse continues.
Nonbank lending
As we head toward the Independent Mortgage Bankers Conference in San Francisco, “experts” continue to warn regulators about the financial stability of non-bank lenders. There is no doubt that nonbank lending has increased around the world.
In the United States, non-depository lenders currently account for roughly 60% of residential lending, per the Urban Institute. Industry analysts argue that non-banks or less regulated and more financially fragile than bank-owned lending operations. But their market share has ballooned. Give or take, nonbanks now account for about half of all residential mortgages, up from 20% in 2007, and about 75% of FHA and VA loans.
Nonbank lenders are arguably regulated by a patchwork of state and federal agencies that lack the resources to adequately oversee them, so risk can easily build unnoticed. And while the Federal Reserve lends money to banks in a pinch, it does not do the same for independent mortgage companies. Relative to production, they have little capital of their own and scant access to cash in an emergency. They rely on warehouse lines. But as we know a liquidity crisis can cut a company off at the knees, and if a warehouse bank cuts off a lender…
If non-depository lending were outlawed for residential loans, could banks and credit unions fill the void? Although it is highly unlikely, it is an interesting discussion topic within academia, regulators, bank conferences, and the MBA’s conference in SF.
Capital markets
This week the commentary had a primer on duration, which impacts rate sheets and therefore borrowers. The piece prompted Adam Haller, CFA, with North Carolina’s Prime Mortgage Lending, to send, “I had to check my own thinking when you wrote, ‘For those holding mortgages in their portfolio, the portfolio value falls when rates fall, as a larger chunk of those loans are expected to refinance and be paid off.’
“This is nuanced of course. The MSRs most definitely exhibit this behavior as they are an interest rate strip, and for the aggregators / servicers, the negative convexity (value falls when rates fall) is the dominant effect. They of course, off-load the pools of underlying MBS to even larger institutions. The underlying MBS, without the interest rate strip, does still exhibit the general fixed income inverse behavior of ‘value rises when rates fall.’ We see that every day in the TBA market, especially with small moves in interest rates. Today, Treasuries are up a little, and MBS down (of course not equally across the coupon stack). The tug of war is between how much of the value comes from the MBS behaving like a Treasury Bond, and how much of the value comes from the embedded prepayment option.
“As the prepayment option is widely known and generally baked into the valuation by all market participants, my hunch is that the only thing that matters is the slight edge that any participant has in forming those expectations, and how that really plays out on actual pools over time. I’m eager to hear ideas on how to gain an edge in prepayment modeling.
“It’s also discussed that MBS convexity, being negative or positive, is dependent on the level of interest rates. At lower rate levels, the prepayment option is more likely to be in the money, thereby potentially outweighing the change expected by duration. To further complicate matters, the shape and changing of the yield curve plays into the analysis. In short, it’s complicated! I am fortunate to have met some of the people in the business of working tirelessly to figure this all out.”
(Thanks to The Onion for this one.)
Woman Rushes To Hide Fragile Objects, Cover Up Sharp Corners On Tables Before Boyfriend Comes Over
OMAHA, NE—Deeming her entire apartment an “accident waiting to happen,” local woman Jeanine Kratz, 29, told reporters Wednesday that she was rushing to hide any fragile objects and cover up sharp corners on tables before her boyfriend came over.
“I really have to clean this place up as much as possible, because Chuck puts everything in his mouth and I worry he’ll swallow something and then I’m going to end up taking him to the emergency room,” said Kratz as she scrambled to remove any plastic bags the 32-year-old could suffocate on, place a lighter on a higher shelf, and hide any pill bottles that he could somehow “get his grubby little hands on.”
“It’s honestly amazing what he’ll get into, whether he’s climbing onto my countertops, pushing over my television, or sticking his fingers into outlets when I’m not looking. Last time, he fell straight through my glass table—I thought he was going to die. And that’s not even counting the time he piddled all over the carpet.”
At press time, Kratz excused herself to the other room after hearing a thud, followed by a loud wail and her boyfriend crying.
Visit www.robchrisman.com for more information on our industry partners, access archived commentaries, or to subscribe to the Daily Mortgage News and Commentary. If you’re interested, visit my periodic blog at the STRATMOR Group web site. The current blog is, “Home Financing Despite the Partial Shutdown.” If you have both the time and inclination, make a comment on what I have written, or on other comments so that folks can learn what’s going on out there from the other readers.
Rob
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