The rate volatility created by fast-rising inflation, now approaching 8% annualized, and the opposing flight to quality sparked by the war in Ukraine, is complicating an already challenging execution environment in the private-label securities market.
Into March of this year, according to multiple market experts, the nonagency secondary market has been digesting a large backlog of mortgage collateral that was locked and originated last year during a much lower-rate environment than exists today. Most of the mortgages securitized in January and February and into March of this year, according to those observers, were originated last year at rates in the high 2% to low 3% range but are hitting the market this year at a time when rates have been climbing, reaching past 4% recently.
If that sounds like a perfect storm, add yet another jolt in the form of a 0.25% increase to the Federal Reserve’s benchmark federal funds rate announced this week, lifting it off near zero — with some six additional rate hikes planned yet for the balance of this year, until the benchmark rate reaches nearly 2%. (And three more hikes are planned for 2023.)
These multiple market pressures have fueled rate volatility and accompanying pricing-execution pressures that have led to a difficult beginning of the year for the private-label securities (PLS) market, according to market experts, and, as a side effect, sparked a more robust market for whole-loan sales — with loans often being sold at a discount.
Additional pressure on the PLS market has been created by the increase in agency conforming loan limits for 2022, a change that has pushed more high-balance loans toward Fannie Mae and Freddie Mac and away from the private label securitization market. Similarly, the Federal Housing Finance Agency’s [FHFA’s] suspension of the cap on agency purchases of investment properties and second homes this past September has continued to create a drag on those deals flowing into the PLS market.
Atlanta-based MAXEX, a major aggregator of loans for secondary market offerings, in its March market report describes a challenging scene for the nonagency securitization market.
“Rapidly rising rates and widening spreads limited securitization volume in February for both investor [investment property] and prime jumbo issuance,” the report states. “… And, as we noted in last month’s report, the price for loans traded through the exchange has fallen again as well.”
The MAXEX report notes that residential mortgage-backed securities (RMBS) deals backed by investment properties decreased “significantly in February,” in large part due to the removal of the agency limit on purchasing those loans.
“The removal of the FHFA cap in September allowed many originators to sell these loans directly to the agencies at a better execution than the nonagency RMBS market,” the report states.
David Pelka, head of RMBS business and a principal at Minneapolis-based CarVal Investors, said his firm is active in both the residential whole loan and RMBS markets, with 30 years of experience buying, managing and trading nonperforming, sub-performing and reperforming loans. CarVal has acquired some $10 billion in whole loans over the past decade and a half, he added, and securitized $5 billion in residential mortgages across some 14 offerings.
Pelka agrees that the PLS market is under pressure.
“In terms of prime jumbo residential mortgage-backed securities, I expect volume to be challenged due to interest rates and bank portfolio bids,” Pelka said. “Credit, such as non-QM [nonprime mortgages], is under pressure from rates, spreads, and extension risk.
“While there is increased interest from originators to access the non-QM market, this short-term period is very challenging.”
Pelka also points out that the rate volatility plaguing the market predates the war in Ukraine — unleashed late last year by the emergence in the U.S. of the Omicron variant of COVID-19.
“The conflict [in Ukraine] is escalating the problem in RMBS, with continued weak execution on new deals, uncertainty around the path of interest rates and probably some concern with new-origination credit performance due to inflation,” Pelka said.
John Toohig, managing director of whole loan trading at Raymond James in Memphis, said his firm had a record month in February trading mortgages, adding that “it’s exceedingly rare that we get to see a lot of loans trade at discounts, and there was a pretty wide range of discounts, from 95 to par.”
“The loans that are coming online right now [in the PLS market] are the loans that were originated back in November and December [2021], as they’ve worked their way through the pipeline,” Toohig added. “So, the coupons back then were quite a bit lower than market coupons [now].”
He explained that part of the backlog in the securitization market is attributable to the ongoing underwriter shortage in the due-diligence review sector, resulting in many loans “waiting to get diligence and also underwater.”
“That’s not a good combination,” Toohig added.
Another industry executive, who asked not to be named, said some clients have commented on the underwriter shortage, but “it has not significantly slowed the deal steamrollers I’m seeing.”
The executive added, however, that “some folks are taking back more bonds than they expected to, and pricing on some deals has not met expectations.”
“I worked one deal last month [February] that basically broke even,” the executive added.
Echoing the market woes, Justin Grant, director of investor services at Mortgage Capital Trading in San Diego, said at the start of this year, high-balance (HB) loan production was off by 25%.
“I believe it is mainly due to the new conforming loan-limit increases, [which are] allowing some of that market to now fall into a regular-balance [agency] product,” he explained. “That being said, rates from the nonagency lenders on HB loans were already right there with the agencies, so the new price adjustments from the agencies will only help to make a nonagency product more attractive for borrowers.”
That’s the larger takeaway here: the resiliency of the PLS market and its ability to ride out rough patches in the rate environment. Even with the challenges facing it, PLS securitization volume is far ahead of last year’s mark — which was a record year for the re-emerging PLS market.
According to RMBS deals tracked by Kroll Bond Rating Agency, a total of 47 prime and nonprime private-label securitization deals valued in total at $24.6 billion closed through March 25 of this year. That’s more than double the volume over the same period in 2021, the KBRA data shows, when 30 deals closed with a total value of $11.5 billion.
The agency loan-level pricing bumps taking effect April 1 — and already appearing on originators’ rate sheets — are expected to provide a boost to the PLS market at the very time that newer mortgages at more competitive market rates are finally starting to replace the lower-rate collateral that has dominated the first two and a half months of the PLS securitization market.
“I think we’re probably in the later innings of this,” said one expert on the securitization market who also asked not to be named. “We are starting to see securitizations with more of a current coupon.
“I think that will help reset the market because it has largely been digesting paper backed by the lower-coupon stuff. If we can get to a spot where rates are a bit more range bound [less volatile], then I think we’re optimistic that PLS will pick up where it left off last year.”
The expert added that there is demand out there: “People have money to put to work, and you have investors who want the product.”
The Fed’s plan to increase its key interest rate multiple times in the months ahead also will fuel further upward pressure on mortgage rates. That will likely compound volume challenges in the origination market in the year ahead, mainly by further decreasing demand for refinancing. Still, the fact that there is a road map for rates and stemming inflation now drawn out by the Fed also helps to foster more certainty in the market.
“Anytime they [the Fed] can just map it out to the market, it can price it in, but anytime they just talk qualitatively about something, the market is going to run the worst outcome,” the securitization-market expert stressed.
Toohig of Raymond James agrees that the challenging execution environment the PLS market has faced so far this year is likely not a permanent feature, adding that we “will eventually revert back to a normal market as new production comes on and gets through.”
The fact that the PLS market is already well ahead of where it was last year at the same time, despite the rough launch into 2022, should bode well for securitization volume for the full year — absent another major market disruption like Russia’s invasion of Ukraine or the sudden emergence of a new, troublesome COVID variant.
“The market has to work through that old inventory first, and that’s kind of what’s been choking the system,” Toohig added. “I think the real question for those people who are carrying loans during this period is, ‘Did they hedge?’
“Those that hedged are probably in a better spot than those that were carrying loans unhedged. Those are the ones that probably get hurt.”
