Tag: margin calls

Why margin calls are currently causing mortgage rates to rise

Posted on by Evan in Economics & Interest Rates

In a more normal financial environment we expect that when stocks trade lower mortgage rates benefit.  This is because when money flows out of stocks it typically finds its way into the bond market which helps drive yields lower.

However, on many occasions over the past two weeks we’ve seen both stocks and bonds sell-off together causing mortgage rates to rise.  Why has this dynamic changed?

The reason is that many investors, hedge funds, and institutions are having to sell assets because of “margin calls“.

To understand what a margin call it is first important to understand that many investors borrow money in order to purchase financial securities.  By employing leverage they are able to increase their return on equity (when the value of these securities rise).

The lenders who lend money on margin require that investors keep a certain proportion of equity relative to leverage (much like loan-to-value ratio on a home).  For example, if a bank is to lend an investor $1.0 million on margin they may require that the value of the account maintain a level of at least $2.0 million.

When the value of the securities decrease below this level, the lender issues a “margin call”.  This call forces the investor to sell assets and raise cash to pay back the loan.

If enough investors are forced to do this concurrently, as they are in today’s environment, then the financial markets are flooded with securities and values of all asset classes decrease together.

This is why in today’s market, we are seeing the stock market decline AND mortgage rates increasing.

“Margin Calls” are catalyst for rate increases

Posted on by Evan in Economics & Interest Rates, General Mortgage Info.

This is an excellent explanation of what a margin call is and why it caused rates to rise yesterday written by Barry Habib, CEO of Mortgage Market Guide:

So what happened yesterday? As we all know – only fools think that mortgage rates are based on the 10-year Note – many of them in the media. Yesterday’s action simply underscores this fact. History shows us that Mortgage Bonds and the 10-year Treasury Note are only an exact match 1 trading day out of 100. So, watching the 10-year Note for mortgage pricing is the equivalent of using a broken watch to time your appointment.

Yesterday, losses from The Carlyle Capital Group and Thornburg Mortgage decreased their capital to the point where their financial backers had asked for cash back in the way of a “margin call”. What does this mean? Imagine a home that received a loan with a 50% LTV…but a provision in the loan stated that under no circumstances could the equity fall below 50%. And the home would need to be appraised every day to evaluate this. If that home lost significant value, the lender would be entitled to an immediate repayment. And when the home actually decreased in value, the lender would make a call for capital to make sure their margin of LTV was intact…a margin call. If the homeowner had the cash to meet this call – all is fine. But if the homeowner did not have the cash, the only way to satisfy the lender would be a sale of the home. And that is what Carlyle Capital Group and Thornburg Mortgage had to do yesterday…they didn’t have enough cash to meet their margin call, so they were forced to sell mortgage loans that they were holding. This flood of mortgage paper on the market, pushed Mortgage Bond prices lower…much lower. But this didn’t have any impact on Treasuries, which were in fact higher on the day. As we have always said, these two securities trade independently.