Update: Before markets opened Monday morning, the Federal Reserve announced an open-ended purchase program for Treasury securities and mortgage-backed securities, including commercial mortgage-backed securities. Treasury Secretary Steven Mnuchin also announced an expansion of the money market mutual fund (MMLF) liquidity facility and other steps to pump more cash into the financial system.
Between Thursday and Friday of last week, the interest rate on a 30-year, fixed-rate mortgage dropped from 4.15% to 3.63%, according to Mortgage News Daily. Less than three weeks earlier, on March 2, mortgage rates had posted a 52-week low of 3.13%.
The coronavirus-related shutdown of large parts of the U.S. economy once again gets the blame. Unlike just a few weeks ago, when investors were satisfied with high-performing mortgage loans as investments, now investors want cash. In the mortgage markets that means that lenders may exercise rights spelled out in the bond repurchase agreements to demand that borrowers who issued mortgage-backed securities (MBS) meet a margin call (make an additional cash payment immediately) on those securities.
In a post at Medium, Thomas Barrack, executive chair and CEO of Colony Capital Inc. (NYSE: CLNY), argues that staunching this demand on liquidity should be the federal government’s top concern. His particular concern is commercial mortgage-backed securities (CMBS), the commercial real-estate version of an MBS.
Barrack warns that the current sudden demands for cash (margin calls) from lenders threaten a liquidity crisis in the entire real estate market:
If these actions continue in the CMBS market and spread to the broader commercial real estate whole loan market, the economic impact, magnified by widespread total industry shutdowns throughout the American economy, could be exponentially worse than the economic effects of the 1987 crash, September 11th attacks and 2008 recession, combined. The long-term impact on the economy could be catastrophic.
Why not modify the repurchase agreement to delay the call for cash while people who are paying mortgages and the companies that are paying people’s wages are shut down? Because the lenders have to agree and, right now, they prefer cash to promises.
While Barrack may be talking his book, two basic points are largely correct. First, if something is not done to slow or even halt the mark-to-market margin calls, the financial system panic is very likely to be much worse than the 2008 panic following the collapse of Lehman Brothers. Second, loan modifications ought to be forced on lending banks and debt funds in order to prevent defaults.
Barrack suggests that the Securities and Exchange Commission also declares a temporary holiday on mark-to-market rules “which would free up billions of dollars in liquidity overnight.” Those rules, Barrack contends, “have, in the past week, wreaked havoc on [repurchase] transactions.”
To allow for loan modifications, Barrack calls for the suspension of GAAP requirements that a coronavirus-related loan be classified as a troubled debt restructuring. Barrack also wants to suspend implementation of new current expected credit losses (CECL) requirements that became effective last December. His fourth suggestion is the federal government do more “to allow banks to forbear on [repurchasing] collateral without triggering [liquidity coverage ratio] violations.
Colony Capital has seen its share price drop from $4.31 on March 2 to $1.52 on March 20. Shares rose 3.4% last Friday to close at that level, largely on the assumption that the Senate could get agreement on a relief package for businesses and individuals. That agreement was not forthcoming and, while it is still likely, the terms of the deal may be significantly different from the Senate proposal from last Friday.
The company’s shares traded down about 2.6% in Monday’s premarket, at $1.48 in a 52-week range of $1.33 to $6.14. At that share price, the stock’s dividend yield is nearly 30%. The price target on the shares is $5.63.