Why Banks Aren’t Lending More
Why aren’t large depository banks loosening their credit guidelines and lending more money? Market watchers suggest that one reason is the buy-back issue: FNMA & FHLMC have sizable losses on bad loans and are considering forcing eleven large lenders (the biggest being BofA and Chase) to buy back loans which would result in losses of over $100 billion. Not only are banks grappling with that potential issue, but there may also be a lack of confidence in the health of our economy banks, businesses, and consumers. No one wants to borrow money to buy a house or expand their business if they aren’t confident about their job or more optimistic about the economy. And right now, as there often is, investors can’t seem to decide if the bond market (which is pointing toward further weakness) or the stock market (pointing toward stability and moderate growth) is more correct about predicting the future health of the US economy.
Is There A Bond Bubble & Are Rates Set To Spike?
Rates have an inverse relationship with fixed-income prices, meaning that when bond prices go up, rates go down. With the major drop in rates in the last several months comes talk of a “bond market bubble”. Most economists do not feel that we’re in a bond market bubble where there is a disconnect between prices and fundamental reality, but it is still worth talking about. All bubbles follow a common pattern, whether it concerns high-tech stocks, tulip bulbs, or real estate. Initially prices increase when a new opportunity presents itself with the prospect of good returns. Investors become more optimistic and lenders become less risk-averse. Suddenly everyone is chasing prices regardless of fundamental values, expectations become unrealistic, and speculators who are more concerned with short term gains rather than long term returns flood the market. But clearer minds begin to prevail, and insiders start to sell. Asset prices stop rising, panic sets in, and investors rush to unload positions before the next guy, and prices crash.
In the current case of fixed-income securities, however, fixed-income instruments like Treasuries are not new. There have been good returns, but any excitement is certainly tempered by the fact that the federal government will record a $1.3 trillion budget deficit in 2010, with fiscal year 2010 (ending 9/30) seeing Treasury debt issuance of about $2.3 trillion of which net issuance is about $1.7 trillion. At this point it appears that investors are buying bonds out of fear and from being defensive rather than being excited about bond prices rallying and rates dropping. And as we all know, there is little in the way of credit truly expanding – banks are holding onto their capital. Cash continues to be king – maybe the Fed should charge banks for holding onto capital.
Rates Not As Low As Mortgage Bonds Would Suggest
Let’s turn our focus to securities and pipeline hedging for a moment. What’s the scoop on 3.5% securities becoming more active? After all, the 4% coupon (which contains, basically, 4.25-4.625% mortgages) is trading around 103. 3.5% securities are near par. And when you throw some servicing value on there, whether it is .5 point or 1.5 points, it should present a rebate on the rate sheet for 30-yr mortgages around 4%. But this is not being reflected on the rate sheets, and the production is not there yet enough to calm fears of non-delivery issues. Volume in 3.5% securities has been steadily creeping up, and becoming more liquid, but seller’s are still timid of any kind of “short squeeze” if they sell 3.5’s out in November or December, and then rates slide up and they don’t have the production. On top of that, production is still in the mid-4’s, which goes into a 4% security. When profit margins start dropping a little, 3.5% volume should increase.
Who’s Profiting From Troubled Loans
Under the heading, “The more things change, the more they stay the same”, investment banks and “vulture funds” are garnering headlines for securitizing and selling troubled loans. The good news, of course, is that it helps keep the talk of a private mortgage bond market alive, and give servicers an outlet for their bad loans. The bad news, if you want to call it that, is that the pools are made up of delinquent loans rather than original liens. One can expect to see more news about companies with names like Penny Mac, Kondaur Capital, Allonhill, Residential Credit Solutions, Arch Bay Capital, Carrington Mortgage, Equifin Capital, etc., and probably ratings provided by the usual Fitch, Standard & Poors, and Moody’s. The process is more conservative this time around (although I don’t know precise details), with supposedly issuers having to set aside half or more of their assets as a cushion from loss, while the cash flow goes to the investors.
Thursday started off somewhat quietly, but by the end of the day mortgage securities filled with rate sheet current coupon mortgages were better in price by .375. Just as there were numerous prices changes for the worse on Wednesday, the MBS market got it all back Thursday – woe to anyone who locked Wednesday instead of Thursday. And not only did all rates drop, but mortgages “tightened”, meaning they improved more than Treasury securities did. The $29 billion 7-yr auction went well (coming in at less than 2%!) at the same time that the stock market began to falter. Soon traders saw that investors interested in buying mortgages outnumbered sellers, with only $1.3 billion being sold.
Huge economic day today, and so far mortgage bonds are selling off, pushing rates higher.