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Rates, Capital Markets, and Business Plans

Yes, rates have gone up, and bond prices down, since the election. Has the world ended? No. Should any company which has their entire business plan built around refinance business be worried? “Concerned” might be a better term, unless they have a plan to go after purchase business – but then again, every lender has a plan to go after purchase business.

The market knew that at some low rates would end, first after Quantitative Easing and then with the potential of economic stimulus. The jobs and housing numbers have been strong, along with the economy in general, all showing enough strength to “let up on the gas pedal but not necessarily put on the brakes.”

The fact of the matter is that mortgage rates in the U.S., after being wonderfully low for several years, have crept higher. They crept higher for a spell during Ben Bernanke’s time as the Federal Reserve Chairman, and now under Yellen. Is there someone out there who didn’t expect higher rates at some point?

Yes, residential mortgage-backed securities have taken a tumble. But, at least initially, higher borrowing costs so far haven’t held back the housing market. Many, however, think that the higher rates will nip the housing recovery in the bud. Sales of previously owned, and new, homes, have been doing very well in recent months. U.S. home prices have been climbing steadily throughout 2016, and the biggest problem that real estate agents report is a lack of inventory in many markets.

But turning back to the MBS market, Capital Markets veterans know that prices are a result of supply and demand. And if higher rates really do lead to fewer locks and therefore less supply, mortgage rates could actually drop relative to Treasury yields. But, on the other hand, if rates have really moved higher due to genuine strength in the economy, and the demand for agency MBS slows down, we could be in store for higher rates.

Of course, the housing rebound has helped rebuild household wealth, added some confidence to consumers, and allowed borrowers to see a pick up in equity. That is a good thing. But underwriting and documentation standards have increased – a good thing according to most – and therefore the process of obtaining a new or refinanced mortgage remains frustrating because lenders are making more meticulous demands for evidence of borrowers’ finances. And this helps investor demand for MBS, helping push prices higher and rates lower.

The refinance percentage of applications is already down. It reached a peak of the high 70’s a a couple years ago, and is now down in the mid-50% area per the Mortgage Bankers Association. Will purchases replace the lost refinance business? Most say no, and therefore security issuance will be down. In fact, the MBA predicts that lenders will see their refinance business fall farther as a percentage of overall business.

So, what’s a capital markets person to do? The banter on the street is “no free extensions.” In fact, many would prefer their locked pipelines vanish, resulting in a huge market gain because of the pair off monies. But Optimal Blue’s clients are in the business to give mortgages, and a lock is a lock. The volatility has increased hedge costs – we can expect that to decrease as we move forward, and as coupons shift 50 basis points higher. And OB’s clients with agency approval are watching the spread between implied gfees at the agency window versus the security market, thus wringing a few basis points of improvement.