Secondary mortgage market adjusts to higher-for-longer rates 

The bottom line is the housing market remains in flux and is once again adjusting to the likelihood of interest rates remaining higher for longer after being teased by the potential of a falling rate environment. 

This flux has created far more volatility in the housing market, particularly in recent weeks, with the MOVE Index — a measure of rate volatility in the U.S. Treasury market — jumping to as high as 121 in mid-April after ending March near 85. 

Ben Hunsaker, a Beach Point Capital Management portfolio manager who is focused on securitized credit, said that during the past year, nonqualified mortgage (non-QM) AAA bond spreads have actually contracted from 155 to 135, while agency mortgage-backed securities (MBS) spreads have widened from about 118 to 134 over the same period.

“With agency spreads moving out 10 to 15 basis points, you would expect that non-QM spreads also have to widen eventually, otherwise the market’s a little bit out of sync,” Hunsaker said. “On a forward-looking basis, you would expect you don’t have the same tailwinds as you did before.”

Volatility in the Treasury market, which trades at a shifting spread below that of mortgage rates, also translates into uncertainty among housing market investors. Market observers say this normally leads to investor hesitancy and a tendency to keep more money parked on the sidelines. 

“When interest rate volatility goes up, you generally have lower fund flows, which you’ve seen over the last few weeks,” Hunsaker said.

On top of that, mortgage origination volumes are projected to be flat this year in the agency (Fannie Mae, Freddie Mac and Ginnie Mae) sector, and only slightly better on the non-agency (non-QM) side compared to 2023, according to market experts. 

Non-QM mortgages include loans that cannot be purchased by Fannie Mae or Freddie Mac. The pool of non-QM borrowers includes real estate investors, fix-and-flippers, foreign nationals, business owners, gig economy workers and the self-employed.

What does this market uncertainty — marked by low origination volumes and a move toward higher rates for longer — mean for the secondary mortgage market, which creates liquidity for the primary mortgage market via securitization and has a heavy finger on the scale in determining interest rates for homebuyers?

If bond yields rise in the secondary market due to a supply-demand imbalance or because of increased perceived risk, then that also tends to put upward pressure on mortgage rates in the primary market.

HousingWire interviewed a range of experts across the secondary market to get a pulse on the dynamics at play at the end of April across the following sectors: whole loan trading, agency and non-agency MBS, and mortgage servicing rights (MSRs).

Following are excerpts from their responses that reflect on the good, the bad and the ugly of the current market.

Whole loan sector

“When we came into the year, we thought we were in for as many as five or six rate cuts. That was a problem for sellers of loans. For mortgages, specifically 30-year fixed rate, it was hard to find a buyer willing to make a strong premium payment [on a whole loan purchase] when you think you are going to get four or five or six rate cuts, because that meant rates were going to fall and [mortgage] prepayments [due to refinancing] were going to increase.

“However, what we’re discovering is that those folks that had the courage to put that trade on back in the third and fourth quarter of last year are in the first quarter of this year being rewarded. Because if we are now looking at only one rate cut [in 2024], maybe even one hike — although I think that’s still a pretty low probability — but let’s just say we’re flat — then prepayment speeds should remain low. 

“Higher-coupon loans now may [offer] a higher rate of return for longer than someone might have anticipated in a rate assessment that was at the beginning of 2024. … So, basically, if I’m trading [as a seller] a 7% loan right now, I may get a premium — like a solid 102 [over par] or whatever.

“The buyer is going to be happy because the prepayment speeds are likely to remain low given the current Fed stance [of higher for longer], and you can amortize that premium over a longer period of time to get a better yield. So, both seller and buyer are happier with the newer loan.“ 

— John Toohig, head of whole loan trading at Raymond James and president of Raymond James Mortgage Co.

“There’s a lot of cash on the sidelines. There’s a lot of money out there. This translates into whole loans too.

“In RPL and NPL, which are reperforming loans and nonperforming loans, there’s a ton of demand. We just put a bid out recently and … had over 30 bids. That tells you that folks are trying to grab those loans, either for the real estate — if it’s a nonperforming loan … such as for rentals, accumulating assets for their portfolio — or if it’s reperforming, to get cash flows at a discount.

“Those loans [RPL and NPL] are really rich on the demand side, but the only sellers are those who are forced to sell because it’s at a discount, with the stuff we’ve seen trading in the 80s [below par]. 

— JB Long, president of Incenter Capital Advisors 

Non-agency sector

“Rate volatility has persisted in the market. It’s essentially like playing a game of Keno [with bets being placed on] what number when, and that money can be lost doing so is not surprising. From my perspective, transaction volume and mortgage origination volume has been on its back — and stayed on its back — for the last year and a half.

“ … There is a book called “Who Moved My Cheese.” And it is a very simple book that highlights a very important premise. A mouse goes looking around, looking around, looking around, and spends all its time looking for cheese. Then [after it finds the cheese], it just keeps going back to the same place, but the cheese is gone. 

“The mouse forgot the whole reason he ever found the cheese in the first place, and that’s because the mouse remained nimble and adaptive, as opposed to just hitting the same button as many times as he possibly could. The point is we have to continue to evolve with an evolving market.

“ … [For example], one of the big changes in the [agency] CRT [credit risk transfer] market has been a decision by the GSEs to not issue the most subordinate [securities] tranches. They are the riskiest tranches … and they’re the ones that offer the highest return. The supply of that profile has diminished considerably because they’re not issuing it anymore. 

“… So, what happens is those investors go to non-QM subs. … There’s a lot of demand for that sub now [securities backed by non-QM mortgages, particularly those linked to home equity loan products].“ 

— Peter Van Gelderen, specialist portfolio manager in the fixed-income group and co-head of Global Securitized at TCW

“Inflation is running hotter than expected, but I wouldn’t say it’s out of control. We’ve just been kind of consistently in a range that’s higher than what the Fed would like. .. Rates do feel rich. They do feel high, but I think the market has adjusted pretty well to where the rates are and certainly it’s within the range of expectations.

“The credit spreads [for non-agency MBS] have come in throughout the year, and so the [non-agency] securitization market is open, and it’s functioning from the originator through the aggregator to the end buyer. Everyone can still make it work.

“It’s by no means the best market anyone’s ever seen, but [non-agency mortgage] originations are growing. … It’s a market that’s diverse in product types and participants.“ 

— Dane Smith, senior managing director and president of Verus Mortgage Capital

[Editor’s Note: Kroll Bond Rating Agency (KBRA) expects 2024 issuance for non-agency MBS to be approximately $67 billion, up 22% year over year. Home equity lines of credit (HELOCs) and closed-end second (CES) originations are expected to account for $11 billion of the increase. KBRA’s measure of non-agency loans encompasses the prime jumbo, nonprime/non-QM, and home equity lending spaces, as well as credit-risk transfer deals.]

Agency sector

“The lock-in effect [of homeowners staying in place due to low mortgage rates] has taken so many homes off the market that you’re seeing reduced sales volume, which creates fewer issuances of mortgages so that the market doesn’t have to metabolize that many loans.

“… But you still have this issue that the Fed displaced real money investors [in the agency MBS acquisition market] for a whole business cycle, a decade, [before pulling back from the market starting in 2022] and that market just doesn’t reappear overnight.

“… We’ve never had this many people that have a loan that’s so far below prevailing rates. So, we’re in a part of the cycle that people can’t look to a model and say, ’This is what’s going to happen,’ because we’ve never been here before. 

“… Lower interest rates will create more [agency MBS] issuance, but more issuance creates a wider basis [spread from Treasurys] because there’s now a lack of investor demand versus the added MBS supply, and this creates higher primary mortgage rates to account for the lower investor bids for the excess MBS supply.

“… It’s a structural issue that I would love to see more focus on … because if you don’t have a couple of trillion dollars of excess balance sheet out there somewhere that’s priced appropriately, then the homeowner is going to end up paying more for their mortgage than they otherwise would.“ 

— Sean Dobson, chairman and CEO of real estate investment firm Amherst

“I think agency spreads have a pretty high correlation to interest rate volatility, so when you go from relatively low interest rate volatility, like where we came into April, to where we are today, it’s a pretty big shock to the agency mortgage market. 

“And accordingly, you’ve seen agency spreads widen pretty materially. [April has] been a really bad month for agency mortgage-backed securities. … The supply-demand for agency MBS is probably in balance, however, and it’s in balance because there’s very light creation of new agency MBS [about $232 billion of agency MBS issuance in Q1 2024, compared with $223 billion in Q1 2023, according to the Securities Industry and Financial Markets Association (SIFMA)].

“… The money managers who really drove spreads tightening [in the agency market] from middle of last year to the end of last year, they’ve become pretty overweight in agency MBS. … But there’s still a lot of annuity money being deployed from annuity sales, and so that should be a continued tailwind [for the overall secondary mortgage market].

“Insurance is really the 900-pound gorilla in the room driving the bus, so they matter a lot, and there’s not a lot of credit creation that can satiate their needs.“

— Ben Hunsaker, portfolio manager focused on securitized credit for Beach Point Capital Management

MSR sector

“You were able to get [MSR] trades off [much of] last year with interest rates somewhat certain. But then when the uncertainty hit [late in the year, with rates declining] that slowed the fourth-quarter [deal volume], and that’s what was reflected [in the number of deals closing] when we came into this first quarter.

“Then all this data starts coming out and it became obvious that [rate cuts were] not going to happen, and that gave a lot more confidence to the buy side. [MSRs tend to price better in a high or rising rate environment because prepayment speeds are reduced. They tend to lose value in a falling rate environment as mortgage prepayments increase, reducing the payout of MSRs.]

“So, look, pricing began to pick up [as it became clear rate cuts were not likely in the near term], but we also saw an interesting phenomenon. And that is the capital that was tied to highly efficient, highly capable [refinance- and home equity loan-focused] recapture platforms decided it was not as concerned about interest rates [going] either way. 

“If rates do not move, [they are] comfortable with the pricing that they’re paying today based on just the steady prepayment speeds and the cash flows, and they’re clipping coupons each month based off of those payments coming in. However, when rates do move, they are going to be in position to recapture [those customers via refinancing].

“… So, we now have a strong appetite for the MSR asset, whether it’s out of the money — which to us is below prevailing market rates — or at the money, and we also have a strong demand for both conventional as well as government [MSR assets]. 

“I will paraphrase a seasoned veteran in the industry that I was talking to recently, who said candidly, ’I have never seen the market like it is today — how extremely active and busy it is.’

“I’m not calling a peak yet. There’s a lot of interest from some pretty significant [investor] sources, who have a lot of capital [and] who are still looking to buy … And it’s driven again by [a desire to] put units on their platform, maintaining efficiencies, while also then having the ability to recapture when — and who knows when — that market opportunity presents itself.“ 

— Tom Piercy, chief growth officer at Incenter Capital Advisors 

[Editor’s Note: Year to date, Incenter has announced auctions for some $15 billion in new bulk MSR deals, which does not include privately negotiated deals.]

“I don’t know if this is the peak or if … rates are going to continue to go up from here, and MSR values are going follow suit or not. But I think people are of the mindset that it’s now higher for longer [on rates].

“It’s hard because of low [housing] inventory levels and higher interest rates to bring in new originations, but that’s the reason why so many of these servicers keep going back to the same well, with a focus on offering cash-out refinance [or closed-end second liens, or home equity lines of credit] to existing customers, given that can be a source of some volume.

“It’s been a strong [MSR] market [so far this year], with some really attractive execution levels that are, dare I say, being influenced by one’s ability to recapture these borrowers. … It’s hard to convince a borrower with a 3% note rate to cash-out refinance into a 7% note rate, but they can still tap their equity by taking out a HELOC or closed-end second without impacting the rate on their first lien.

“I’ve got probably three or four deals I’m currently working on, so [MSR] volume and pricing are strong. We’ve seen some high-5 multiple trades [historically a great deal in this measure of pricing on MSR pools]. 

“I think [MSR trading volume] this year is going to be on par, if not slightly better, than last year [which would mark the fourth year in a row that the MSR market has recorded trading volume near the $1 trillion level].“ 

— Mike Carnes, managing director of MSR valuations at Mortgage Industry Advisory Corp. (MIAC)

[Editor’s Note: Year to date, MIAC has announced auctions for some $6.4 billion in new bulk MSR deals, which does not include privately negotiated deals.)