Relief from the rate-driven volume reduction afflicting both the primary and secondary mortgage markets is expected to be elusive for some time to come, at least in terms of any renewed refinancing boost.
That’s according to David Petrosinelli, a New York-based senior trader with InspereX, a tech-driven underwriter and distributor of securities that operates multiple trading desks around the country.
“We’re going to have a Fed-induced consumer slowdown,” Petrosinelli said. “We’re going to have a housing correction.”
That correction, well underway, has already taken a hammer to the performance of the private-label and agency mortgage-backed securities (MBS) markets, which are tied closely to lenders’ success in growing mortgage originations. The Federal Reserve’s rate-hiking campaign to combat inflation has greatly chilled originations in the primary mortgage market, with some lenders’ origination volume down as much as 75% year over year.
Consequently, the collateral available to support securitizations in both the agency and nonagency secondary markets has also fallen.
We’ll have a lag in when people refi because even if there is a rate incentive to do it, there may not be the price incentive to do it.
David Petrosinelli managing director at InspereX
Petrosinelli said that even if the Fed takes its foot off the accelerator on the rate front sometime during the first quarter of next year, as some market experts predict could happen in the best-case scenario, there will still be a lag effect before conditions improve for the housing industry.
“The Fed on average … over the last two decades, usually cuts rates about four or five months after the Fed funds rate has peaked,” he said. “The Fed could begin cutting rates by June [of next year], in the summertime, by that metric.
“But it’s not just rates, because property values will probably also have continued to drift lower, so ultimately, if you want to refi, I don’t imagine that it would be very easy to do that if you’re off 5% to 10% in prices. We’ll have a lag in when people refi because even if there is a rate incentive to do it, there may not be the price incentive to do it.”
HousingWire spoke to a half-dozen industry pros in the primary and secondary markets for their takes on when normalcy might return.
Dour outlook
A recent report on the private-label residential mortgage-backed securities (RMBS) sector by the Kroll Bond Rating Agency (KBRA) reveals that a dour outlook for the mortgage-origination market also reverberates in the secondary market.
“Unsurprisingly, 30-year mortgage rates are near 7%, up almost 5 points this year, a level virtually unfathomable during the past decade,” the KBRA report states. “The magnitude and speed of this change has contributed to an unfavorable spread environment that has continued to negatively affect issuance across all sectors of RMBS in [the second half of] 2022.”
KBRA defines RMBS as all nonagency prime, nonprime (including non-QM) and credit-risk transfer issuance.
We project Q4 2022 to be the lowest RMBS securitization issuance volume in any quarter since 2016, closing at less than $6 billion.
Analysts at Kroll Bond Rating Agency
“KBRA now expects full-year 2022 RMBS issuance to top out under $102 billion,” the report continues, “down from a heady $122 billion [in 2021]. Such an outcome would equal an almost 17% decline relative to 2021 volume.”
On the bright side, KBRA also notes that 2022 will still be the second highest RMBS issuance year since the global finance crisis some 15 years ago and nearly double the $55 billion issuance mark in 2020. Still, much of that good news for 2022 is front loaded.
“In terms of quarterly issuance, it tapered quickly in Q3 2022 and did not reach our projected issuance expectations of $20 billion, instead closing at almost $17 billion,” the report states. “Similarly, we project Q4 2022 to be the lowest RMBS securitization issuance volume in any quarter since 2016, closing at less than $6 billion.”
For 2023, KBRA expects the mortgage interest-rate environment to remain elevated “as will other sector headwinds, including home-price declines, high inflation and potential volatility owing to changing economic conditions and geopolitics.”
Those factors will contribute to a 40% decline in RMBS volume in 2023, down to $61 billion, according to KBRA’s projections.
The outlook for agency MBS issuance — securities issued by government-sponsored enterprises such as Fannie Mae or Freddie Mac — is equally grim, according to Robbie Chrisman, head of content at Mortgage Capital Trading (MCT).
“Gross issuance of all agency mortgage bonds has declined for eight straight months to now sit at its lowest level since April 2019, below $100 billion a month and about one-third of what we were experiencing at this point last year,” Chrisman wrote in a November market-outlook report. “That trend likely won’t change going into the new year, as December, especially its latter half, sports the lowest average daily trade volume for any period of the year.”
Agency mortgage-bond gross issuance, Chrisman notes, is projected to end 2022 at around $1.8 trillion, compared with the $3.3 trillion average posted during the boom years of 2020 and 2021.
The drop-off in agency and nonagency MBS issuance makes sense when you consider the most recent origination forecast by the Mortgage Bankers Association, which shows overall loan production declining from $4.43 trillion in 2022, to $2.24 trillion for this year and $1.97 for 2023. The bulk of that decline is on the highly rate-sensitive refinancing side.
MBS challenges
From the point of view of investors and broker-dealers, Petrosinelli said, the current MBS market is not all that attractive, given the volatile rate environment.
“I remember the first few bonds I bought [decades ago],” he recalled. “My boss kind of looked at me and scratched his head. I said, ‘Look at the yield on this bond.’ And he said, ‘Well, the coupon is 200 basis points below Fed funds.’”
If the bond’s coupon rate is lower than prevailing interest rates, then the bond’s price is discounted. That can be a problem for the holder of the bond in a rising rate environment.
“… Particularly if you’re a broker-dealer, owning that kind of coupon, you’re upside down to start because there’s a carry cost with that,” Petrosinelli added. “So, you have to make all of your profit on price appreciation.”
“It’s just a tough scenario to get really excited about, and it’s probably one of the reasons why you see the Street is really not flush with [RMBS] inventory now, which is an understatement.”
Until the Fed concludes their hiking cycle, volatility and illiquidity in the secondary market will continue,” he said. “Once the Fed stops raising rates, the market could be expected to normalize.
Andrew Rhodes, senior director and head of trading at MCT
Thomas Yoon, president and CEO of non-QM lender Excelerate Capital, said the lender postponed plans to conduct its first private-label securitization offering this year “because the last thing we want to do is go to market for the first time and get crushed.” He added that “the premium goes away [on a securitization deal] if rates jump too fast.”
“In the worst-case scenario, [some lenders] may securitize to get the assets off their balance sheet, but they might lose money doing it,” he explained.
Andrew Rhodes, senior director and head of trading at MCT, stressed that persistent inflation is “the major headwind” confronting the housing market.
“Until the Fed concludes their hiking cycle, volatility and illiquidity in the secondary market will continue,” he said. “Once the Fed stops raising rates, the market could be expected to normalize.”
John Toohig, head of whole-loan trading at Raymond James, said as rates continue to rise, “that’s just going to continue to put pressure on supply.”
“There’ll be fewer loans originated [going forward], so there will be fewer loans able to go into a bond issue,” he added.
Keep hope alive
Sean Banerjee, co-founder and CEO of ORSNN, a Seattle-based fintech start-up that offers lenders and private-equity funds access to a cloud-based electronic whole-loan trading platform with embedded quantitative analytics capabilities, sees the dropoff in mortgage originations due to rising rates as the main driver of “the shrinking securitization market.”
Over the longer term, however, especially if we face a recession in 2023, resulting in a more stable to declining-rate environment, Banerjee says the reduced mortgage production could create favorable pricing conditions for the both the agency and private-label securitization markets.
“Based on lower volumes, the market could become more efficient,” he said. “If [loan] issuance is slow to recover, which it may be due to tightened lending [standards], a possible recession [next year] and associated unemployment, an intriguing supply-demand dynamic can occur.”
A substantial secondary infrastructure was built to accommodate the behemoth agency MBS issuance during 2020 and 2021, and now those operations — as well as whole-loan trading businesses — need to be right-sized for the new normal.
Miki Adams, president of CBC Mortgage
He added that such a “recession scenario” could bode well for the MBS market in 2023 — even as the nonbank lender market undergoes a major restructuring. That in turn, would make the MBS market a more attractive liquidity outlet for the surviving lenders.
“If there are fewer [quality loan] pools to choose from, [sellers] are going to be able to command a higher price than they would in today’s current market just because of the lack of supply,” he explained. “That same dynamic holds true for agency MBS as well as nonagency.”
Miki Adams, president of CBC Mortgage, a provider of down-payment assistance and one of the largest nonbank second-mortgage lenders in the country, summed it up this way:
“A substantial secondary infrastructure was built to accommodate the behemoth agency MBS issuance during 2020 and 2021, and now those operations — as well as whole-loan trading businesses — need to be right-sized for the new normal.”
