Drinking From a Firehose is Not a Long-Term Business Model

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Rob Chrisman's Perspectives
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Over the last few weeks the United States has seen stocks prices sink, oil prices sink, and yields sink. The impact of the coronavirus, which no one saw coming, and only a few predicting its sway on economies, is being felt. The Federal Reserve on Tuesday, March 3 made an emergency cut to the federal funds rate, citing “evolving risks” stemming from the global coronavirus outbreak.  “The fundamentals of the U.S. economy remain strong,” the Fed said in its statement. But nobody really knows how bad things might get and the outlook is getting grimmer by the day. My guess is that the Fed believes it’s better to be safe than sorry.

From an originations perspective, why should lenders care? After all, rates are great! The U.S. Treasury market tends to be a money safe haven as investors sell global stocks and buy U.S. Treasuries. But if enough money floods the U.S. Treasury market, long-term bond rates could sink below short-term bond rates, the condition commonly known as an inverted yield curve. Banks tend to reduce or stop lending when shorter-term money is more expensive than longer-term money, making continued economic expansion harder. If banks have to offer depositors higher short-term deposit rates than they can charge on long-term business loans, they are losing money and carrying the risk that some loans will default. That means the banks might just say no to new business loans, helping spur an economic downturn.

For several months now the Federal Reserve’s Open Market Committee was seen to be “on hold,” content with short term rates where they were. Once again, the “experts” were wrong. But the actual Fed move did not have a huge impact. U.S. growth had already slowed slightly, although the job market is still very healthy. In fact, the housing market has been a bright spot in the United States. Starts and permits are good, helping to alleviate some of the inventory issues that some parts of the nation have seen. In fact, the markets are ignoring the current good data from the United States.

So what are STRATMOR’s clients doing, or talking about, with this unforeseen down move in rates? After all, Treasury, and mortgage, rates have gone down so far, so fast, it is being termed as “dangerous” by some in lending. One must be careful what they wish for. Everyone would agree that mortgage rates 50 basis points higher than where they are now would still yield plenty of refis for the industry. And low rates are certainly helping the purchase market to a degree.

Top CEOs warn of cracks in the manufacturing process, and fatigue among employees. They are taking a close look at changing pay structures, bonusing people to work weekends, and providing spa certificates. At some point money doesn’t matter, and lenders must show appreciation to employees for working long hours. Managers are keeping a close eye on production metrics to stop burn out, or at least do their best to minimize it.

Some lenders (gasp!) are trying to slow things down, prioritize business, knowing that this will help them in the long run with clients and with their reputation. Lenders are offering extended lock periods for free, or providing free extensions. Fortunately, the monthly drop in mortgage backed securities (MBS) is minimal given the shape of the yield curve. Some are shifting refi lock periods out while emphasizing purchase business and reminding real estate agents that they are still able to close a purchase in two to three weeks. No one is reducing profit margins to gain more volume. Other lenders, who have the ability, are shifting manpower from divisions that have slowed down to bolster the ranks of those originating refinances. Many have gone to their staffs for suggestions on how to slow things down and maintain long-term credibility for their clients.

Lenders are bracing for Early Pay Off notices seeking money. EPO penalties are fees that originating lenders must pay whenever a loan pays off based on the contract that the lender signed with the investor, usually within four to six months of funding. Borrowers are not responsible for these fees. And lenders who have float down policies in place are gauging the cost of them in this environment. When things slow down, will they be re-evaluated?

In the capital markets lenders who have hedged their pipelines must contend with paying for margin calls from broker dealers. It is truly a cost of doing business. Broker dealers, which is where lenders hedge their pipelines by selling MBS to protect their locks’ pricing, do not renegotiate. This is also a cost of doing business.

In summary, low rates are fine, and keeping many originators busy refinancing their own book of business or trying to refinance the loans their competitors have done recently. But if there truly is an economic drag from any epidemic, the coronavirus or something else, a slower U.S. economy is not something to look forward to. And smart lenders know that drinking out of a fire house for any length of time is bad. STRATMOR’s smart clients are doing things to maintain control over their business, knowing this is the best course of action over the long run.

Impact on servicing values is another story….

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