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June 8, 2022 | Premium Service | A number of subscribers to The Institutional Risk Analyst have been asking about different regions of the mortgage and asset management complex. Creators and servicers of loans are currently in disfavor, but some investors are beginning to nibble on the real estate investment trusts (REITs). We’ll be looking at a number of asset gatherers and managers in upcoming issues of the Premium Service.
Here’s the key questions: First, do you expect the yield on financial assets and particularly mortgage-backed securities (MBS) to rise faster than funding costs? And second, how do you feel about mortgage servicing rights (MSRs), which seem to be the plat du jour among the REIT community in this cycle? As the housing market rolls over and asset prices begin to fall for the first time in a decade, credit costs will reappear in at least equal measure.
Interest Rate Volatility
The big worry we see ahead is the fumbling approach of the Federal Open Market Committee to normalizing monetary policy combined with the rapid pace of change in the markets. Bill Nelson, Chief Economist of The Bank Policy Institute, illustrates the problem faced by the FOMC compared to the Bank of England:
“The BoE plans to set the interest rate on its collateralized loans equal to Bank Rate, the rate it pays on deposits (reserve balances). It then plans on shrinking its securities holdings at least until borrowing picks up, which should happen at roughly the unknown structural short-run level of reserve demand,” Nelson noted in a missive earlier this week. He continues:
“By contrast, the Fed’s plan is to stop QT ‘when reserve balances are somewhat above the level it judges to be consistent with ample reserves.’ At that point, the Committee will let currency growth reduce reserve balances until the balances are ‘at an ample level.’ The New York Fed is basing its balance sheet projections (available here) on an assumption that that minimum ample level is 8 percent of nominal GDP (the level in December 2019) and will be reached in 2026 when reserve balances are $2.3 trillion.”