
DEAN C. CASO – ‘Tough position’
Business is good in the refinancing market. In fact, some mortgage companies are experiencing record years. Not since the last cycle ending in 1998 have numbers been so dramatically high.
But the refi boom hasn’t been all roses. In fact, some investors in mortgage-backed securities may be getting paid back too quickly, according to some observers. That’s all part of the game, however, and those experienced in the industry know it, say other industry watchers.
Repayments have soared since the first Federal Reserve rate cut in January. Since then, the Fed has reduced rates seven more times and is expected to cut rates again tomorrow. This has been a boon to consumers, as they’ve watched even long-term loan rates drop to as little as 6.5 percent.
The Mortgage Bankers Association of America Refinance Index sat at 2682.7 for the week prior to Sept. 25, 1998, during the last refi boom. It crept to a high of 4389.1 in October 1998. Already this year, the index showed a rate of 2713.9 for the week prior to Sept. 21, a significant jump from a rate of 1992.9 during the week of the terrorist attacks. The composite index, which guages refinancing application activity, was set at 100 in March 1990.
Questions remain, however, as to whether there is currently a sustained refi boom. “It’s kind of waned a little bit …We’re at the end of the last one. Rates are lower, markets aren’t quite back to normal,” said Marangal “Marito” Domingo, executive vice president of capital markets for Washington Mutual’s home loans and insurance services group, in reference to the terrorist attacks three weeks ago.
“I think it will be another four to six weeks before we can determine whether we’re at another,” he said.
A plethora of prepayments, however, could further exacerbate already skittish investors.
When a mortgagee refinances, that reduces the investment and investors get their money back “too soon,” said Domingo.
“In general, that is the nature of the mortgage securities market. [Investors] typically come in with their eyes open to this fact,” he said.
Domingo said despite overall nervousness in the market, it remains a “robust market.”
“Those types of investors should have no problem getting right back in and buying another mortgage security. Typically I would then put it in another security,” said Domingo.
However, Bob Segal, a portfolio manager with J. William Mantz Investment Advisors in Gloucester, said investors may be disappointed when it comes to reinvesting their premature returns.
“It hurts the investor in that they get their principal back and they’re investing it in a lower rate environment,” he said.
Segal said earlier in the year, investors were putting money back into the market. In January they sold, trying to take cover.
“Right now, I think it’s too early to get a sense as to what investors are going to do. There’s still the feeling that it could just be a temporary dip in mortgage rates. Investors are probably going to sit tight. They might buy 15-year mortgages that have shorter terms,” explained Segal. In that way, he said, they’ll make their expected principal back quicker.
“It could be just a temporary dip in mortgage rates. What the market is trying to resolve right now is the Fed’s pumping money into the system. By next year, what we may be looking at is the combination of the Fed putting so much money into the system, and all the government spending, could cause higher inflation down the road. It means the government surplus, that was supposed to be high, we’re not certain where that’s going to go now,” said Segal.
‘Credit Risk’
Also of concern is the looming recession. With layoffs gaining momentum before the Sept. 11 attacks and the hundreds of thousands of people laid off afterward, Segal said it is likely there will be some tightening in the subprime lending market. But jumbo loan markets should remain strong. Rates may go a little bit higher in relation to Fannie Mae and Freddie Mac rates, he said.
The overall effect boils down to two factors, said Domingo. The first is the uncertainty and chaos that followed the attacks, from which investors are still recovering.
“[In the] longer run, I think the big question remains the economy. The tone of the mortgage market will take the tone of the greater concern of the recession. In a recession, clearly mortgage securities have much more protection than others. Mortgage securities are a haven; however, they do carry some credit risk as well. People need to have concern about their appetite for credit risk,” he said.
Ginnie Mae mortgages are fully backed by the federal government, guaranteeing that investors will be paid even if the borrower defaults. Fannie Mae and Freddie Mac are government-sponsored enterprises, which, by the nature of the approval conditions, is a more secure risk. Private securities are less secure, but may yield much higher results as a result of higher interest rates charged to subprime borrowers.
However, Domingo said typically rated subprime securities should perform “OK.”
Consumers will continue to determine the economy, and when they get nervous, so do investors, said Domingo.
At the other end of the scale, originators and wholesalers are carefully watching consumers and are concerned consumers will be tempted too often to refinance by increasingly lower rates.
According to Dean C. Caso, president of Homevest Mortgage Corp., the constantly dropping rates aren’t necessarily all good for business. If a customer refinances once, then again within 90 to 100 days, it has a negative effect on the wholesaler, Caso explained. Then they charge back the premium to the service provider.
If a wholesaler sells a loan to be securitized, the wholesaler will retain the servicing spread. “That servicing spread is typically much larger than the cost to service the loan, which creates an income stream, an annuity of sorts, of the term that loan is going to last,” explained Nathan Hagan, president of Secondary Marketing Resources in Stoneham.
The accounting rules require the annuity be recorded at the time the servicing asset is created. If the recorded amount reflects five years’ worth of servicing income on the balance sheet and the payoff comes before that, the wholesaler is out money if they don’t charge back the amount to the servicer.
“They were counting on that servicing income, and many of their contracts will require an automatic charge-back as part of that servicing income should the loan pay off in the first year,” said Hagan.
“It’s a tough position,” said Caso. “Because if interest rates fall one-half a percent within 90 days, we’ve got a quandary. If we refinance, then we could have a charge-back.” But if they refuse to refinance again, the borrower simply goes to another mortgage company.
But the investor may also call back the mortgage company and renegotiate a new price that will be beaten elsewhere in any event.
Rapidly falling rates may sound good to consumers in general, but it’s not indicative of good times.
“You don’t want to see interest rates nose down or shoot up. In an ideal situation, the rates will fall slowly,” said Caso.