Fitch Ratings released a report Wednesday suggesting that rising interest rates could pose new challenges for investors in U.S. mortgage bond markets. Within the $6.8 trillion market, the higher rates would affect the current U.S. private label and agency mortgage-backed securities markets, banks with significant, mortgage-related exposure and the structure of U.S. mortgage finance. Elevated rates would expose trading-oriented investors to heightened price volatility, particularly those that are highly leveraged, funded through repo markets or mark-to-market their holdings, according to the report. In a rising rate scenario, U.S. banks’ current MBS holdings of roughly $1.3 trillion would face either mark-to-market losses or, if held on a long-term basis, lower net interest income. Liability-sensitive banks would also face re-pricing risks on mortgage loans held in the banking book, potentially squeezing net interest margins, the report said. Higher mortgage rates would also dampen housing affordability, motivating originators to offer more initially cheaper floating rate and hybrid adjustable-rate mortgages, Fitch said. However, a shift away from the traditional 30-year, fixed-rate mortgages would transfer interest rate risk from lenders to borrowers, running contrary to the current public policy focus on mortgage product simplicity and consumer protection, the report said. By reducing the appetite of banks to retain mortgages on balance sheet, a rising interest rate scenario might also stimulate securitization markets, which enable mortgage originators to transfer interest rate risk to institutional investors who prefer long-duration assets. Potential losses in a rising rate environment could significantly exceed credit-related losses, with strengthening underwriting standards mitigating credit risk on new mortgage originations. U.S. government debt is at record levels and 10-year Treasury yields are starting to increase from their generational lows, which could lead to rising interest rates over the next several years, according to the report. Rising rates would also pose risks to both mortgage lenders and investors in MBS, who over the past 20 years have benefited from a falling rate environment. Write to Shaina Zucker.
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