Q&A with Mortgage Industry Veteran Paul Van Valkenburg

With MBS issuance falling to a 23-year low, what does that mean for people trying to secure a mortgage?

Issuance of mortgages is low because of higher rates. But what I anticipate (and what is already happening) is that originators will utilize this excess capacity to move into originating lower credit mortgages – non-qualified – which will predominantly be put on their balance sheet.

There are mechanisms to securitize and sell these assets, but these are not as fluid as they were in the past due to risk retention rules designed to protect the solvency of these markets.

In the private label securities market, the thinly-capitalized originator has been eliminated because of this concern about counterparty risk, and the risk retention rule ensures the issuer retains at least 5% of the equity in a deal. It is an option but is a stronger barrier to entry.

These factors have created the conditions for TBA futures. Is having access to a variety of risk management tools vital in the current environment?

An exchange traded futures contract has had long standing appeal but to figure out the nuts and bolts of making it a success has been a major challenge, so congrats to you guys for getting it done. That it permits deliverability is a big plus. It can service mortgage banking constituents who can utilize it as if it was an over-the-counter futures contract.

So when it has institutional support across different sectors, it has the capability to service a broad spectrum of the market – which means when there is upheaval, there are going to be people on the other side who can help continue the liquidity in the market.

Recessions are a natural part of an economy’s cyclical nature. Generally, when you have a recession, you have a systemic decline in rates to combat lower demand and stimulate consumer spending. But if you have an increase in unemployment, you are also going to see credit events happening where there are more delinquencies and defaults.

With FINRA 4210  – which will collect margin on TBAs to help manage potential risks –scheduled to go live in October, what do you see coming down the line?

This comes back to counterparty risk. Let’s first look at the current over-the-counter market. There are layers of risk management where you have the highly liquid inter dealer market, traded through the screens, where all the liquidity and the capital is.

The next layer out is the regional dealer or broker, but they are not really putting capital up. Their role is to address the counterparty risk by taking the credit risk of the counterparty risk of the mortgage originators who have less capital.

So this counterparty risk is outstanding, and if we look at what happens when markets are under stress, such as in the sub-prime or global financial crisis, as you move down the food chain, parties are left exposed.

The regulators recognized the disruption this causes, and they have wanted to bring capital and margin standards to this over-the-counter TBA market. That was why FINRA proposed its 4210 rule for margin requirements in 2016, but there has been reluctance to implement the rule because market participants feel it is too disruptive.