By comparison, agency net MBS issuance in 2021, when interest rates were half of what they are today, came in at $870 billion, according to Amherst. Net issuance in MBS represents new securities issued less the decline in outstanding securities due to principal paydowns or prepayments.

Spread expansion

Adding to the woes in the agency MBS market are outsized spreads, with the spread between the 30-year fixed mortgage and the benchmark 10-year Treasury hovering around 2.9 percentage points in early December, when historically that spread has ranged between 1 to 2 percentage points. That wide spread has squeezed margins on agency MBS, with 6% coupons at yearend 2023, for example, trading at a fraction of a percentage point above par, down from nearly 10 points above par at the end of the first quarter of last year.

Amherst Chairman and CEO Sean Dobson said the shrinking margins in the agency MBS sector are a byproduct of an over-supply of paper and a greatly reduced investor balance sheets for absorbing the debt. A major purchaser of agency MBS until last year was the Federal Reserve, he explained, which is now allowing up to $35 billion of MBS to roll off its balance sheet each month.

The reduced role of the Fed and other investors in the agency MBS market is acting as a type of governor on rates, preventing them from getting much downward traction. As origination volume increases, and related MBS issuance goes up, so does the supply of MBS for sale in the market — creating downward pressure on prices, assuming buyer demand remains repressed.

Andrew Rhodes, senior director and head of trading at Mortgage Capital Trading, said a loan originator is trying to estimate where their end investor is going to be buying the loan, “so whether it’s the whole loan or the securitization, they are trying to figure out exactly what that price is going to be.” 

“Then the independent mortgage bank (IMB) can originate the loan to that level because that’s how they’re really managing that margin,” he added. “And if all of a sudden, your investor that you thought was going to be spending 103 or 104 [for that loan or MBS] is now at 102, that’s a big hit to that origination volume that you thought was going to be getting a point or two higher in price.”

Dobson said heading into the end of 2023, the securitization market “is structurally impaired right now because the normal sponsor [investor] base is absent.” 

“Some of them are gone forever, and some of them are basically going to have to rebuild capability,” he said. “…This is speculative to a certain extent, but should rates go down, and should a lot of [new MBS] supply get created because of refinancing activity, the market is going to have a really hard time with that. 

“…So, now the question is, what’s the new level that gets it [MBS] to clear when the normal sponsors [investors, such as the Fed] are offline, and that new level is an excess return that’s now something like 50 basis points wider than corporate bonds.”

Amherst projects that in 2023, the pull-back of the Federal Reserve as well as the banking sector from the agency MBS market will result in a combined $425 billion in excess MBS that will need to be absorbed by other investors, such as money managers and foreign investors.

“I think the Fed will not sell MBS but rather is prepared to keep letting the portfolio run off, even if they start cutting rates,” said Richard Koss, chief research officer at mortgage-data analytics firm Recursion.

 “The Central Bank has expressed its interest in reducing its role in the mortgage market and would rather cut rates more if needed, rather than slow down the process of reducing its holdings of MBS,” Koss added.

Bank contraction

In addition to the reduced role of the Fed in the MBS market, the banking industry and other investors also have pulled back from MBS purchases in the wake of financial pressures sparked by rising rates — as well as plans by regulators to tighten bank capital-reserve rules. 

“The problem is … the benchmark of fair [MBS] value was set when the GSEs [government-sponsored enterprises, Fannie and Freddie] could buy [MBS], when the banks could run huge balance sheets, when the REITs [real estate investment trusts] could run big balance sheets, and when the regional banking system wasn’t [impaired],” Dobson said.

Over the past year, a number of large banks have collapsed — among them Silicon Valley Bank, Signature Bank, First Republic Bank and Signature Bank.

“I think there are seven or eight banks total that exited warehouse lending this year, [such as Comerica and Fifth Third Bank],” said Charley Clark, a senior vice president and mortgage warehouse finance executive at EverBank (formerly known as TIAA Bank). The unit does warehouse and MSR lending “and really anything that relates to lending to IMBs [independent mortgage banks],” according to Clark.

The top 15 warehouse lenders as of the end of the third quarter of this year had extended nearly $80 billion in warehouse line commitments, representing about 80% of the market, according to an Inside Mortgage Finance report.

“We were not part of this, but there were definitely funding and liquidity issues [for banks this year], not only just liquidity issues in general, but the cost of funding on the margin,” he added. “So, it was not only hard to find deposits, but they’re expensive. 

“And if you look at something like warehouse lending [to IMBs], the spreads are very tight. If you’re a bank that’s having liquidity and funding issues, what are you going to cut? You’re going to go to the lower spreads to cut, right?”

Other sectors

The narrative is similar for the private-label residential mortgage-backed securities (RMBS) market. 

A yearend forecast report by the Kroll Bond Rating Agency (KBRA) projects that RMBS issuance in 2023 will come in at about $52 billion, down nearly 50% from 2022 and $10 billion below KBRA’s original projection for the year issued in November 2022. KBRA includes prime, nonprime, credit-risk transfer transactions and second-lien offerings in its RMBS analysis.

“[Reduced] mortgage volumes and continued spread volatility in a rising rate environment contributed to a meaningful issuance decline [in 2023],” KBRA’s recent forecast report states.

Ben Hunsaker, portfolio manager focused on securitized credit for Beach Point Capital Management, said for real growth in the housing market to occur, mortgage originations need to increase substantially along with higher securitization volumes, “and it doesn’t seem like that’s highly likely right now.”

“In the case where the Fed cuts [the benchmark rate by] 250 basis points, I’m not sure that’s necessarily a scenario where housing volumes are great and housing prices are strong because that would probably be pretty correlated with a really weak consumer or some recessionary-type outcome,” he added. “And then you have to have wider spreads [due to increased risk], which means the value of creating those mortgages and securitizing them is again hampered.”

If there was one bright spot in the secondary market in 2023, it was the mortgage-servicing rights (MSR) sector, which performs better in rising-rate environments because mortgage prepayment speeds slow to very low levels and returns from parked escrow deposits also rise — both of which help to pump up the value of MSRs. Trading volume in the MSR sector in 2023 is on track to slightly exceed 2022’s $1.1 trillion mark, according to Tom Piercy, chief growth officer at Incenter Capital Advisors(previously Incenter Mortgage Advisors).

“For 2022 [on MSR trading volume], my numbers were right around 1.1 trillion, and I expect 2023 to be slightly greater than that,” Piercy said. “However, I think it [trading volume] was front-end loaded over the first six to seven months of the year … but we continue to see the capital commitments to invest in MSR both from your traditional bank, and nonbank servicers, as well as the MSR investors. 

“And so, I’m still quite bullish on where we are today, as we forecast the capital and the ability to absorb the MSRs in the market.”