How Low Rates Unwind Fed’s MBS Holdings

Under the, “Hey, if you’re going to downgrade our debt, we’re going to look into how you miss-rated mortgage securities five years ago…” category, the U.S. Justice Department is investigating whether or not S&P erred in rating MBS’s. Somehow Fitch & Moody’s, which just confirmed their highest rating for U.S. debt, aren’t in the headlines.

Low Rates Unwind Fed’s MBS Holdings
During this August refi boom, many loan agents that they are moving borrowers from 30-yr mortgages in the high 4’s down into 15-yr loans in the low 3’s. And that trend is being reflected in the MBS volumes that are being sold in the marketplace, with 15-yr MBS percentages creeping up. And remember all those mortgage-backed securities that were purchased by the Fed a year or two ago? The Fed’s portfolio in particular has a sizable amount of 5% coupons and lower largely made up of credit-eligible borrowers. Forecasters believe that early pay-offs over the next 12 months from the Fed will be $230 billion, up from a $140 billion outlook estimated earlier this year when interest rates backed up and prepayments began slowing. In a report from Deutsche Bank, analysts estimate a total of $575 billion over the next 12 months coming from the Fed, GSEs and Treasuries – all of which must be absorbed by the private sector as the government entities aren’t buying MBS.

Rates Aren’t Always Passed To Loan Agents/Consumers
When asked outright, practically no loan rep that I ever ran across begrudged their company making a profit on a loan. After all, it is the owners that have their capital at stake, and the ability to make a profit is critical for any mortgage company. This topic has come up again with the recent record MBS prices that are being seen by traders and investors, yet those great prices are sometimes slow to appear on retail rate sheets. (As a quick aside, in the supermarket business, the shorter the shelf life of a given food the higher the markup, so the markup on meat is about 60%, while it is only about 26% on canned goods.) By the time a MBS price finds itself on the lender’s rate sheets, profit margins, hedge costs, competitor’s prices levels, overhead, cost of funds, etc., all take a piece out of the pie. Loan reps should keep that in mind.