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COVID-19 Impacts the Mortgage Industry
Published: April 2020
Author: Bank of England Mortgage Staff
What is the Coronavirus (COVID-19)?
According to the CDC (Centers for Disease Control and Prevention), a novel coronavirus is a new coronavirus that has not been previously identified. The virus causing coronavirus disease 2019 (COVID-19), is not the same as the coronaviruses that commonly circulate among humans and cause mild illness, like the common cold.
The virus that causes COVID-19 seems to be spreading easily and sustainably in communities (“community spread”). It is thought to spread mainly from person to person. Primarily those that have come in close contact with one-another (within 6 feet) and through respiratory droplets produced when an infected person coughs or sneezes.
With COVID-19 now classified as a pandemic, economies have come to a standstill.
Impact on Mortgage Industry
As the coronavirus continues to spread rapidly, investors have begun to rebalance their portfolios to less risky assets such as treasuries, bonds and mortgage back securities (MBS).
The Washington Post stated, “As interest rates fall, the demand for refinancing seems to be skyrocketing. But this is a volatile market. This month, 30-year fixed-rate mortgages were hovering around 3.25 percent to 3.5 percent. Then, they were at 4 percent, as investors flocked to 10-year Treasuries, and the Federal Reserve announced it would be buying mortgage-backed securities. Demand for bonds won’t help mortgage interest rates or housing affordability.”
Supply Shortage & Rate Whiplash
Much like the toilet paper shortage we are facing at this time, the demand for refinance loans were higher than the flexibility of mortgage capacity at lenders and banks.
Just two weeks ago, mortgage rates fell to all-time lows, driving mortgage applications to levels not seen since 2009. This is no longer the case. Housing wire stated the mortgage business continues to try to deal with the repercussions of interest rates hitting an all-time low, it appears that some lenders are inflating their advertised mortgage rates to try to stem the tidal wave of mortgage applications they’re receiving. It’s safe to say that the mortgage industry is suffering from a little bit of “rate whiplash” right now.
Banks and lenders have funded billions of dollars in mortgages to sell as Mortgage Backed Securities (MBS), others also rapidly sold these assets to raise capital which caused the secondary markets to become flooded.
The oversupply of MBS meant buyers were not purchasing the assets as quickly as they hit the market which sent the the price of MBS coupons plummeting. The drop off in MBS value caused mortgage rates to spike 1-2% in rate within a few days!
Keep Your Distance
Several stores and chains are closing nationwide and worldwide in response to the coronavirus pandemic. These closures are intended to promote social distancing, the act of decreasing person-to-person contact in order to slow the spread of the disease.
As these social distancing orders were enforced, many of these closed businesses have been compelled to lay off millions of workers. The fear of illness has turned into a major economic concern as analysts realized that homeowners without jobs may not be able to pay their mortgage payments.
FEDS Step Up
The economic impact of social distancing has led to risks of a major long-term recession. The Federal Reserve came together and dropped the Fed Fund Rate to near zero percent.
The Federal Funds Rate is the interest rate target at which banks borrow and lend excess reserves from one another on an overnight basis. A committee of the Federal Reserve sets a target federal funds rate eight times a year, based on prevailing economic conditions.
As News Outlets claimed that rates were now at 0%, homeowners flooded lenders with requests to refinance. What failed to be explained was the fact that even though the Federal Funds Rate had been decreased, mortgage rates did not.
Refinance Requests
With the influx of refinance applications soaring, servicers began to panic. A servicer buys mortgage servicing rights (MSR) which is the ability to collect payments and pass them on to the end investor when a loan is closed. This is when they receive a fee for servicing the loan.
Typically, they need 3-4 years of collecting payments to break even on their purchase of servicing rights. If clients refinance, there are major losses for servicers. The potential for early payoff losses dropped the value of mortgage servicing.
FEDS Step In Again
As a flood of refinancing hit, the value of MBS (Mortgage Backed Securities) and MSR (Mortgage Servicing Rights) dropped at unprecedented rates. When the value of holding mortgages drops, mortgage rates jump up rapidly.
High mortgage rates would be destructive in a slow economy. In an attempt to drive down mortgage rates, the Feds announced a bailout package which included the daily purchase of billions in mortgage backed securities.
Back & Forth
With the Fed bailout package announced, FED began buying billions of MBS. Which caused the MBS value to increase back up and leading to a drop in mortgage rates.
The problem is that the Fed's plan overlooks the unintended consequences to mortgage lenders and mortgage servicers. If rates drop too rapidly, they lose a significant amount of money. Lenders have major costs from hedging the markets to lend and have to contribute huge sums of capital which may need to be borrowed at high rates. Lenders then have to pass these extra costs on in the form of higher mortgage rates.
Mortgage servicers lose value as MSR values drop. Mark-to-market accounting slashes their asset value which affects their ability to access additional capital they need to stay in business. The Feds bailout packages do not address the fact that mortgage servicers are required to pass payments on to investors even if they do not receive payments from the borrowers. They may be obligated to billions of dollars in payments that they did not receive.
Ultimately, the government has created an environment where mortgages have become a hot potato. The ones left holding it could end up with significant losses or even bankrupt.
Tightening Guidelines
The U.S. battle with the coronavirus has left some Americans struggling to pay their bills, including mortgage payments. As state and local governments continue to order business closures, lockdowns and curfews, out-of-work homeowners are wondering how they’ll afford housing costs.
Homeowners have been encouraged to call their mortgage company to seek payment relief during this economic slowdown. With this high potential for default risk, the mortgage industry has reverted to tactics we saw in the 2008 housing collapse. Banks and lenders began tightening guidelines, adding lending overlays, and discontinuing products.
The Perfect Storm
The combination of market unpredictability and unintended consequences from the government have left mortgage lenders and servicers bewildered. Until the storms calm and the coronavirus is better controlled, we will continue to see more restrictions on loans and less people qualifying for mortgages.
Light on the Other Side
Before the coronavirus hit, the underlying economy and housing market was very strong. Businesses were thriving with historically low unemployment.
The government will need to inject cash into consumers’ hands to stimulate the economy and promote growth. To do this, they will continue buying MBS which should keep long term mortgage rates low.
The US Treasury Secretary and Ginnie Mae have begun working on solutions for the short term liquidity issues of lenders and servicers which will calm market volatility in weeks ahead. Once the financial markets begin to recover, many economists believe that there will be a rapid bounce back.
Credits
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FAQs - CDC.GOV
Coronavirus Closures – ABC7.com
How the Coronavirus Broke Mortgages – Anthony Bird
How Coronavirus will Change Closings, Home Prices and What’s on the Market – Washington Post
Super Low Interest Rates Disappear from Mortgage Comparison Sites – HousingWire
As Interest Rates Increase from Record Lows, Mortgage Applications Fall Back from 10 Year High – HousingWire
COVID-19 Will Cause a Record-Setting Recession - HousingWire