Boardroom view.

BOARDROOM VIEW

Interest rate volatility returned with a bang when Iraq invaded Kuwait. Mortgage bankers we talked to said the unsettled situation in the Middle East has produced wild swings in market rates every day since the saber rattling began.

As if managing the pipeline was not hard enough in tamer markets, secondary marketing managers now are shaking their heads and remembering the late 1970s and early 1980s. Executives we talked to say they are trying to stay hedged even though that is costing dramatically more than prior to the invasion.

The Iraqi military action against neighboring Kuwait has "created a tremendous amount of volatility in the capital markets, "which in turn has affected secondary marketing operations," according to Louis Jennings, director of the secondary marketing division, Navy Federal Credit Union, Vienna, Virginia. The market volatility has had a two-fold impact on this mortgage lending operation, Jennings said. The first is just trying to deal with the volatility itself, which complicates pricing and other areas of any mortgage operation set up to deliver loans into the secondary market. Jennings said that since the invasion, he has seen "two to three point [rate] swings in the same day." He adds, "I haven't seen volatility like that in almost 10 years." The rate volatility is perhaps even more difficult to handle since secondary market managers have not had a lot of practice dealing with wild rate swings lately. Until now, rates had settled into trading within rather confined bands. So, the current situation is a bit of a test for those who run the secondary operations to see if they are still on top of their games.

The other way the Iraqi aggression has directly affected Jenning's operation is it dramatically raised the cost of buying options to hedge his pipeline. "Options had been fairly cheap in recent months. That all ended with the Iraqi invasion of Kuwait," according to Jennings. He had priced the same options contract on the Wednesday prior to the invasion, that he finally bought on the Tuesday following the announcement of the Iraqi action. The cost for the same $1 million options contract jumped $3,000 immediately following the news of the Mideast crisis, he said. That represents a 38 percent price increase, he noted, but he bought them anyway.

Jennings explained that most mortgage bankers hedge through options so this is a higher cost component that is likely to be absorbed by many in the business. He said that the cost of options is tied directly to volatility in the market--the greater the volatility the higher the price. So, that extra $3,000 that Jennings paid is purely a result of market volatility.

Jennings concedes that the market's being in a tizzy has created other headaches for the secondary marketing manager. Navy Federal typically hedges in one way or another roughly 70-75 percent of the loans in its pipeline.

Currently, the pipeline has about $125 million in loans coming through. But he said, because of the uncertainty over the Iraqi situation, "I don't quite know what type of coverage to buy." Jennings noted that as long as rates are rising, pipeline fallout goes down. But he says it's difficult to judge how far out into the future rates will continue trending upward. With the unpredictability of the Iraqi situation, it is difficult to surmise the duration of the conflict and its attendant hold on the U.S. capital markets. As a result, Jennings said, "I'm juggling with what my new pipeline fallout is going to be."

And as if that weren't enough ways that an armed invasion thousands of miles away is taking domestic mortgage lenders for a rollercoaster ride, Jennings adds one more way that the situation has affected his business. The week we talked to Jennings, Navy Federal had experienced 40 percent more loan applications than it had been averaging in recent weeks. He attributes the stampede to a run by borrowers to beat expected rising rates brought by the Iraqi hostilities. Navy Federal allows borrowers to lock-in over the phone and then gives them 72 hours to come in and fill out an application. Jennings said his operation did not raise their mortgage rates immediately after the invasion started affecting the capital markets. He said they waited until they saw where rates were going and as a result got a rush of borrowers.

He said he had not seen any loans fall out of the pipeline as a result of Navy personnel being called to active duty and not being able to complete the application process. If such a situation arose, he said Navy Federal would work with the borrower to prevent the loan from falling out.

As for the outlook for rates, Jennings offered this comment: "I don't even have a gut feel for where rates are going because of the volatility." He added that long-term rates "should be trending down." The most recent unemployment figures that showed a rise to 5.5 percent "should have produced a [bond] market rally," he said, but that "was all mitigated by the unsettled Middle East situation." Jennings said that if the bond market could shed its jitters over the Iraqi-Kuwait confrontation, then rates should settle down. He noted that recent data on the economy rather convincingly suggest "this market is in a rather pronounced slowdown."

When asked how origination volume was holding up for the year, Jennings said that Navy Federal was "having a pretty good year." He quickly added, "I hope this doesn't put the nix on that." Before the invasion, Navy Federal was on track to post its biggest origination dollar volume year ever. "This could change that, of course," Jennings said.

Another mortgage lender in the heart of the Atlantic Coast defense belt is Essex Financial Partners, Virginia Beach, Virginia. Lawrence N. Smith, chairman of Essex Financial, also noted the difficulty of trying to run a mortgage operation when you are tied to money markets that are behaving erratically. "The problem with running a financial institution is when the money markets are reacting violently on every rumor, it makes everyone's life very difficult," Smith said. He noted the impact the recent rate climb has had on consumers. Homebuyers had been warming up to the stability that had been perceived in mortgage rates lately. Smith said that rates had firmed up on the perception that the economy was nearing a recession and that produced a comfort level on the part of borrowers that if they acted now they weren't going to miss the boat when rates dipped dramatically lower. Then, he said, "all of a sudden" the Iraqi situation had a "dramatic impact on pricing and whether you can afford a house or not" by moving mortgage rates up swiftly.

Smith had some strong words for the Federal Reserve Board's apparent low profile in the current military crisis and the impact it's having on the U.S. capital markets. "I think it's astounding that [Fed Chairman Alan] Greenspan has disappeared into the woodwork. His silence is deafening." Smith added that he gave Chairman Greenspan "extremely high marks for stepping in October 1987 [when the stock market crashed,] but I can't say the same thing for August 1990." Smith believes that the Fed needs to play a vocal leadership role to calm the markets from gyrating off of every rumor in a time of market unrest.