MBA Raises Concerns with SEC on Broker-Dealer Margin Call Volatility

The Mortgage Bankers Association, in a letter Sunday to the Securities and Exchange Commission and the Financial Industry Regulatory Authority, raised “urgent concern” about dramatic price volatility in the market for agency mortgage-backed securities over the past week that leading to broker-dealer margin calls on mortgage lenders’ hedge positions that are unsustainable for many such lenders.

The letter to FINRA President and CEO Robert Cook and SEC Chairman Jay Clayton urges them to call on their regulated broker-dealers to work constructively with their mortgage lender counterparties in response to the COVID-19 outbreak.

“Greater flexibility during this period would enhance financial stability and mitigate severe threats to the functioning of the housing finance system that already is operating under significant duress,” wrote MBA President and CEO Robert Broeksmit, CMB.

The letter notes in mid-March, as the impact of the COVID-19 outbreak became more acute, the agency MBS market – typically one of the most liquid fixed-income markets in the world – was besieged by a lack of buyers, a sharp decline in liquidity and rapidly falling valuations. These dynamics caused significant strains on a variety of agency MBS investors, many of whom are critical participants in the housing finance system.

MBA noted the Federal Open Market Committee took decisive action, increasing the Federal Reserve’s purchases of agency MBS to restore liquidity to this market. “Conditions have since improved and agency MBS valuations have risen rapidly,” the letter said.

However, a full week of such large-scale agency MBS purchases and the subsequent rally in agency MBS valuations produced a new set of market dynamics that is harming a wide range of mortgage lenders. The letter noted many mortgage lenders hedge their pipelines of new originations by taking short positions in the To-Be-Announced (TBA) agency MBS market. Over the past week, agency MBS valuations have risen dramatically.

“While lenders can expect to recognize gains on their pipelines, they will also recognize losses on short TBA positions used for hedging purposes,” MBA said. “These pipeline gains will be recognized over a period of weeks, but the sharp movement in lenders’ hedge positions typically entails daily adjustments and margin calls from their broker-dealer counterparties. Because of these dramatic price changes, broker-dealers’ margin calls on mortgage lenders reached staggering and unprecedented levels by the end of the past week. For a significant number of lenders, many of which are well-capitalized, these margin calls are eroding their working capital and threatening their ability to continue to operate.”

Broeksmit said MBA has been made aware of many cases in which “lenders in strong financial positions only a few days ago will not be able to meet these margin calls after only another day or two of market movements at the pace observed last week. The inability of a large set of responsibly-managed lenders to meet these margin calls would jeopardize the very objective of the Federal Reserve’s agency MBS purchases – the smooth functioning of both the primary and secondary mortgage markets.”

Further, MBA said, in recent days many financial regulators have emphasized the importance of regulated institutions working with customers and counterparties in a flexible manner in response to the COVID-19 outbreak. “MBA believes this flexibility should extend to broker-dealers’ treatment of mortgage lender hedging practices,” the letter said. “These practices represent sound business decisions by companies that are critical to the continued flow of mortgage credit to consumers. Their inability to operate and lend would exacerbate the already significant negative impact that the COVID-19 outbreak has had on the national economy.”

MBA urgently requested FINRA and the SEC issue guidance to the nation’s broker-dealers, making clear that margin calls on mortgage lenders’ TBA hedge positions should not be escalated to destabilizing levels. “Absent such guidance and an immediate shift in broker-dealer practices, the U.S. housing market is in danger of large-scale disruption,” MBA said.