The Difference Between Bonds and Men?

I could tell that my cat Myrtle was incensed. I think that it may have had something to do with an email regarding artic krill oil, and her clicking on a link to check on the status of the prize that she’d won, supposedly a lifetime supply. After clicking on link everything she had in her trust fund vanished. Easy come, easy go. If Myrtle falls for something like this, how many employees fall for things like, “Your benefits have changed; click here to see your new health plan,” or, “Your retirement fund needs to be moved; please click here for options.” It’s critical to put your employees, old and new, through regular testing. (No, this is not a paid ad.) Switching gears, and very similar to the residential lending industry, according to a new DeWalt Powering the Future survey nearly half of U.S. contractors say training the next generation is critical for the industry’s 2023 growth followed by contingency planning and resilient supply chain solutions. Despite the widespread layoffs and salary cuts in our biz these days, and the spate of experienced talent looking for jobs, at some point there will be hiring, and lenders and vendors will want sources of younger staff. This was also a recurring theme during the MBA’s conference earlier this week. (Today’s podcast is available here. This week’s is sponsored by Richey May, a recognized leader in providing specialized advisory, audit, tax, technology, and other services in the mortgage industry and in banking.)

Broker and Lender Products, Services, and Software

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How Bonds and Mortgage-Backed Securities Work

What’s the difference between government bonds and men? Bonds mature.

Don’t worry… I won’t make your eyes glaze over. The question always comes up, “Rob, when my capital markets staff says ‘Bonds are going down’ do they mean in price or yield are going down?” Price is not the same thing as yield. But usually if someone in capital markets says that “The market is going down” that typically means that mortgage-backed security prices are going down, and rates are going up.

I’ll give you an example. Let’s say a year ago MBS investors were buying 3 percent Freddie and Fannie securities at par, or 100, or dollar for dollar. Now, however, they can buy those same securities and earn 6.5 percent.

Why would anyone want to earn 3 percent when they can earn 6.5 percent on their money? No one would. But what if they could buy those 3 percent securities, not at a price of 100, but at a price of 85 or 90 cents on the dollar? And that discounted price gives an investor a yield of 6.5 percent?! At that point an investor may be indifferent about buying a new bond yielding 6.5 percent at 100 or an older bond yielding 3 percent at 85.

But wait, there’s a little more! Which one is going to be on the books longer? Or has less credit risk if the economy moves into a recession? That is reflected in the value of the servicing, so even though the price of the bond can be calculated mathematically, the actual price of the MBS will be influenced, or muted, by other factors.

That’s the basic reasoning in the price/yield discussion. But moving on to some bond basics, mortgage-backed bonds consist of pooled mortgages on real estate, residential mortgages in our case. But investors in fixed-income securities have other options, and may shift their purchases and holdings based on minute differences in the perceived value of various instruments. Short-term U.S. Treasury Bills, longer-term Treasury securities (notes and bonds), Treasury Inflation Protected Securities (TIPS), municipal bonds issued by cities and towns, Agency Bonds sold to fund federal agriculture, education, (and mortgage lending programs), corporate bonds issued by companies, junk bonds (typically corporate bonds), and convertible bonds (corporate bonds that can be converted into stock at certain times throughout the term of the bond), are all out there in various ways.

Many bonds are issued for a specific length of time, called the “term to maturity.” A fixed amount of interest gets paid to the investor every six months or year, and the principal investment gets paid back at the end of the loan period, on what is called the maturity date. In some cases, the interest is paid in a lump sum on the maturity date along with the principal investment funds. But MBS are different: borrowers may refinance or sell their home, and pay off their portion of the MBS.

In general, bonds in the secondary market are priced based on their interest rate, their maturity date, and their bond rating. Notes with higher interest rates and more years left until maturity are worth more than those with low rates and those that are nearing maturity. But as noted a few times above, MBS have the added complexity of prepayment risk influencing the prices that investors will pay. And investors often demand a higher yield to compensate for the possibility of prepayment.

As noted above, a Mortgage-backed Security (MBS) is a debt security that is collateralized by a mortgage or a collection of mortgages. An MBS is an asset-backed security that enables investors to profit from the mortgage business without the need to directly buy or sell home loans. Lenders may issue their own MBS, or sell the loans to aggregators who do that, or sell loans to Freddie Mac or Fannie Mae, or securitize FHA & VA loans through the Ginnie Mae program.

MBS often end up with insurance companies or pension funds. When an investor buys a mortgage-backed security, it is essentially lending money to home buyers. In return, the investor gets the rights to the value of the mortgage, including interest and principal payments made by the borrower. Lenders selling the mortgages they hold enables banks to lend mortgages to their customers with less concern over whether the borrower will be able to repay the loan. The bank acts as the middleman between MBS investors and home buyers. Who is servicing the loan matters, especially during times of refinancing.

Ginnie, Fannie, and Freddie? As a response to the Great Depression of the 1930s, the government established the Federal Housing Administration (FHA) to help in the rehabilitation and construction of residential houses. The agency assisted in developing and standardizing the fixed-rate mortgage and popularizing its usage. In 1938, the government created Fannie Mae, a government-sponsored agency, to buy the FHA-insured mortgages. Fannie Mae was later split into Fannie Mae and Ginnie Mae to support the FHA-insured mortgages, Veterans Administration, and Farmers Home Administration-insured mortgages. In 1970, the government created another agency, Freddie Mac to perform similar functions to those performed by Fannie Mae.

Freddie and Fannie charge gfees. Why? They guarantee timely payments of principal and interest on these mortgage-backed securities. Even if the original borrowers fail to make timely payments, both institutions still make payments to their investors. Know that the government does not guarantee Freddie Mac and Fannie Mae. If they default, the government is not obligated to come to their rescue. However, the federal government does provide a guarantee to Ginnie Mae. Unlike the other two agencies, Ginnie Mae does not purchase MBS. Thus, it comes with the lowest risk among the three agencies.

Capital Markets

We had a third straight rally in the bond markets yesterday despite the release of a better-than-expected advance reading of Q3 GDP, which gives the Fed an argument to continue its aggressive rate hikes. Treasury and MBS prices also rose despite the day’s $35 billion 7-year note auction meeting weak demand. Real GDP increased at an annual rate of 2.6 percent in Q3, ending a two-quarter streak of negative GDP prints. Separately, durable goods orders increased 0.4 percent month-over-month in September, less than expected due to some softening in business spending, which was evident in the 0.7 percent decline in non-defense capital goods orders excluding aircraft.

These numbers suggest the economy held up well in the third quarter as it started to acclimate to rising interest rates.

Rates do seem to be on an inescapable path upward. The ECB hiked its policy rate 75-basis points yesterday, as expected, adding that they had made “substantial progress” towards removing policy accommodation. This week’s Primary Mortgage Market Survey from Freddie Mac saw the 30-year mortgage rate exceed 7 percent for the first time in over 20 years. For the week ending October 27, the 30-year and 15-year rates rose 14-basis points and 13-basis points, respectively, to 7.08 percent and 6.36 percent.

Today’s economic calendar is busy, and we’ve already seen September personal income and spending (+.4 and +.6 percent, as expected) along with Q3 employment costs (1.2 percent, as expected) and core PCE (+5.1 percent). Later this morning brings final October Michigan sentiment, the Pending Home Sales Index for September, and following yesterday’s ECB meeting, the Bank of Japan will be out with its latest decision. We begin the day with Agency MBS prices worse .125-.250 and the 10-year yielding 3.99 after closing yesterday at 3.94 percent.

Employment and Transitions

Here we grow again! Towne Mortgage Company, a multi-channel, national mortgage lender with the strength and stability of 40 years in business has added 2 industry veterans to the Team. We are excited to announce Brian Lindenmayer and Lydia Whittingham. Despite industry downsizing and the challenging market, Towne is still growing, full steam ahead! Towne Account Executives prospect and originate across all channels (Wholesale, Non-Del, and Fully Delegated) and across the country free of specific territories, a huge advantage in a slowing market, giving them the opportunity to excel in a declining market. As a seller/servicer we have full access to FNMA/FHLMC/GNMA agency product sets, renovation (203K, FNMA HomeStyle & FHLMC HomePossible), no minimum FICO FHA, manual underwrites and manufactured housing loans. All this, and we service most of our loans! If you’re looking for a generous compensation plan, an all-encompassing benefits package, and a one-of-a-kind Business Support Team, look no further. AE’s interested in Towne opportunities please send your confidential inquiries to Mark Zierott.

“Clearly MGIC is a special place to work and has the best retention because three rare openings are available due to our long tenured staff retiring! Although it’s bittersweet to see them go, we’re excited for the new opportunities this has created! MGIC currently has 3 Account Manager positions available in Massachusetts (applicants residing in NE Massachusetts, SE New Hampshire, or Southern Maine), Oregon (applicants residing in Portland), and Sacramento! The Account Managers maintain a sales relationship with MGIC customers in their respective territory, effectively manage activities with customers, work closely with National accounts, business development teams, underwriters, and regional processing centers, identify new opportunities, make sales calls, enhance customer relationships, and attend various MGIC events and conferences. Requirements include working knowledge and experience in Residential Mortgage, Real Estate Sales, Mortgage Banking and/or Financial Services, ability to travel overnight, ambition, and great communication and presentation skills. Send resume to Marisa Avila!”

LoanLogics (think loan quality technology for mortgage manufacturing and loan acquisition) announced several executive leadership changes, including the departure of CEO Bill Neville, who hands over the reins to new CEO Dave Parker.