We previously noted that the recent surge in bank deposits, that is related to rising risk aversion associated with the onset of the Covid-19 crisis, serves to support bank investment in agency Mortgage Backed Securities (MBS). A look at recent Federal Reserve Board data reveals that growing MBS demand is not just the result of greater deposits, but also is due to a desire on the part of depository institutions to reduce risk in the mortgage space.
April mortgage deliveries by the agencies Fannie Mae, Freddie Mac and Ginnie Mae showed a rise in deliveries of mortgages to the two agencies for both home purchases and refinances. Purchase mortgage volumes reflect a normal seasonal pattern, while refinances experienced a sharp spike upwards in response to low levels of interest rates. Given normal (and possibly growing) lags related to closing times, many of these contracts were signed in March when rates had already dropped sharply but the full impact of the Covid-19 virus on stay-at-home policies was not yet fully felt.
Just-released data from Freddie Mac is the first clear signal of distress in the conforming mortgage market. Data at the pool level for April 2020 showed a record high share of 30-day delinquencies (dq’s) of 3.735% for pools backed by 30 year mortgages. This data set goes back only to January 2011, so to get a reference to the Global Financial Crisis (GFC) we calculated the 1-month dq for 30 year mortgages from the Freddie Mac Loan Performance data set which goes back to 1999, although the most recent observation is June 2019. This dataset consists of a large sample of Freddie Mac loans but is not the whole universe. During the period of overlap there is a clear correlation between the two series. Finally, we overlay the insured unemployment rate to obtain a clear connection between the shock to the labor market from the Covid-19 virus and borrowers who have missed their mortgage payment.
As noted in an earlier post we discussed how the GSE’s have been sharing credit risk with private investors through the Credit Risk Transfer (CRT) market. At that time, we discussed how losses tended to grow over time, and noted the significant geographical variation in default rates by state, reflecting local economic conditions. Another consideration noted along these lines is underwriting characteristics. This impact is particularly notable when comparing the performance of loans for lower-credit quality borrowers to others. The chart below looks at the relative performance in CRT high-LTV reference pools between those with FICO scores less and equal to 680 and those greater than that score:
During the 2008 global financial crisis, the agency multifamily CMBS (commercial mortgage backed securities) and the RMBS (residential mortgage backed securities) markets performed differently as measured by delinquency rates. For example, at the peak of the financial crisis in Feb. 2010, single family Fannie Mae loans had a 90+ day delinquency rate of 5.6% in Feb. 2010, compared with their multifamily 60+ day delinquency rate of just 0.8% in Jun. 2010. However, the historical performance cannot guarantee the same relationship will hold during the current Coronavirus pandemic. The huge surge in unemployment currently being experienced will fall equally on renters and homeowners alike. The CARES act provides forbearance to households with mortgages, but there is no such broad program for renters.
With the onset of the Covid-19 crisis, the role of the banking sector has once again risen to the forefront of concern. As noted in an earlier post, the sharp spike in unemployment is certain to lead to a surge in delinquencies. Banks play a significant role in the mortgage pipeline as originator, servicer and investor. In our previous post, we noted that the onset of the crisis has triggered a flood of cash flowing into bank deposits as households and others shed risky assets. As such, banks have more assets to invest, including in the mortgage market.
Banks like mortgages as an investment, spurred by solid fundamentals related to firm labor markets and rising, but not overly stretched home prices. Banks are protected from credit and default risk by owning agency MBS instead of mortgage whole loans and enjoy favorable treatment from the capital rules set by the regulators. According to Federal Reserve data, in Q4 2019 banks held about 25% of the $9.6 trillion agency MBS market. To understand the behavior of banks in this market it is important to probe its underlying structure.