“Every call for government intervention [in the marketplace] creates unintended consequences, which lead to calls for further government interventions.” – Ludwig von Mises
By some measures, U.S. banks have spent $600bn in compliance since the Financial Crisis of 2008. A positive development of 2020 and 2021 is that the money appears to have been well spent, with the banking sector showing resilience, mortgage-based assets performing, and banks’ strengthened capital cushions proving adequate to COVID related distortions thus far.
But the macro economy has also been propped up by USD $3.6tn of fiscal support committed by the Federal Government so far (twice the amount of intervention as in the Great Recession) and an additional $1.9tn round of stimulus entered the budget reconciliation process in February. Additional government/central bank interventions affect the mortgage market more directly, including:
- Foreclosure and eviction moratoria: While executed at the state and local level, many of these moratoria have already been extended (e.g., New York State’s initial deadline was August 2020 and is now May 2021; The new administration has proposed extending the Federal moratorium until September 2021).
- Federal Reserve purchases in 2020 of $458 billion of agency MBS from mid-March to mid-April, followed by $203 billion from mid-April to mid-May. Since March, the Federal Reserve has purchased $1.05 trillion of agency MBS (comparable to the $1.25 trillion purchased between January 2009 and March 2010; Fed holdings detailed below in figure 1).
RMBS Market During Covid
“Buying mortgages in March was one of the best trading opportunities in mortgages since the last financial crisis,” – Daniel Hyman, PIMCO head of agency MBS Portfolio Management
These interventions have supported individual borrowers and the functioning of the broader markets with undetermined consequences for other stakeholders in mortgage value chain (e.g., originators, servicers, mortgage bondholders). As the United States experiences changes in intra-country migration patterns and a new administration takes power in Washington, it is topical and relevant to take a deeper look into potential effects of these interventions and trends on the expected functioning of RMBS markets.
This intra-country migration has led to high demand versus supply in the housing market; additionally, large scale of Federal Reserve intervention suggests that the Fed is “buying the market” from a secondary market perspective. Combined with an influx in deposits from a drop in consumer spending during COVID, banks have plenty of liquidity to make advances through the mortgage value chain. As a result, credit ratings for non-GSE securities—a better barometer of market health than government backed agency securities—have been largely stable throughout the pandemic.
Market participant expectations are that refinancing and high issuance will persist, servicers will continue to modify loans as opposed to foreclosing, and that the Fed will maintain RMBS purchases. In short, that prepayments will remain more of an issue than a wave of defaults reminiscent of the Great Recession.
What is the upshot of this market stability for banks?
RMBS is a complex, relatively illiquid, and capital-intensive product. Most market participants have in-flight efforts to create new models (e.g., fulfilment engines, valuation platforms, or risk treatments) and/or are preparing for upcoming capital standards (i.e., FRTB, SA-CCR) with special attention paid to the fact that structured products will benefit more than other asset classes from IMA vs SA FRTB capital treatment. While keeping a close eye on prudential standards and any statistical harbingers of unforeseen market developments, banks have the freedom to continue both these efforts specifically and related, foundational efforts (e.g., market data storage for IMA time series creation) as planned before COVID.
“You see, son, we lump thousands of these Margaritaville instalment plans together into Margaritaville-based securities, then chop those securities up in a way that we could sell them to banks.” – South Park
After the Great Recession, South Park famously satirized the mortgage market, specifically the distance of borrowers from the ultimate capital behind their purchases. But, as many commentators have said with different flavors, the causes of crises are different. Thanks to bank reforms, strong government response, and consumer savings, the RMBS market is functioning and banks have displayed adequate capital cushions for the moment. Banks should take comfort that their efforts—coupled with government support—have shown material benefits to the safety and soundness of the financial system while keeping their focus on in-flight initiatives to continue to make the RMBS market more liquid, transparent, and efficient moving forward.
Capco has extensive experience helping our clients plan their RMBS strategy (e.g., capital savings/cost analyses) as well as executing both RMBS-specific initiatives (e.g., complex model migrations, model tuning) and related foundational work (e.g., market data object standardization, time series creation). We would love to schedule a call with your team to discuss RMBS considerations in greater detail.
Contact us to learn more.