Mortgage Mayhem Hits Broker ED&F With Mounting Margin Calls

(Bloomberg) — The aftershocks of a chaotic rush to offload mortgage bonds are spilling over to regional broker-dealers facing mounting margin calls.

ED&F Man Capital Markets Inc. has been hit with growing demands to post more capital to cover souring hedges in its mortgage division, according to people with knowledge of the matter. The requests are coming from central clearinghouses and exchanges, forcing the firm to put up almost $100 million on Friday alone, the people said, asking not to be identified because the information isn’t public.

The $16 trillion U.S. mortgage market, at the heart of the last crisis, finds itself in turmoil again, prompting the Federal Reserve to intervene with promises to buy unlimited amounts of Treasury bonds and mortgage securities. Growing fears that good loans will go bad are setting off a bout of pain rippling across the industry and prompting speculation that other types of support might be needed.

ED&F, whose hedges exceed $5 billion in net notional value, has been in discussions with the clearinghouses and has met all the margin calls, one of the people said.

A representative for ED&F declined to comment.

Funds holding mortgage-backed securities have been racing to dump them to shore up cash and meet redemptions and their own margin calls. Some, including Invesco’s mortgage REIT, have already said they are unable to meet the demands. Bonds changing hands at fire-sale prices are prompting a precipitous drop in the value of the securities that’s straining dealers’ books.

The exact nature of ED&F’s TBA hedges couldn’t be determined.

Many mortgage-backed-securities deals are purchased using borrowed money, with a small percentage as a down payment. When asset values drop, the creditor lending that money might suddenly demand a higher percentage, resulting in margin calls.

“It starts affecting pricing throughout the whole system,” said Brian Egnatz, founder of Milepost Capital Management.

TBA Market

Regional dealers often originate residential mortgages so they have loans they can bundle to use in the to-be-announced, or TBA, market.

A typical trade for bank clients like regional dealers is to be long mortgage securities using TBAs. Regional dealers need to hedge against mortgages falling, so they short U.S. Treasuries with counterparties such as larger banks. The two trades are combined and become an uncleared swap, which is subject to higher margin requirements.

Earlier this month, a rally in U.S. Treasuries led to the 10-year yield note falling by about 60 basis points. At the same time, a rush to sell mortgages caused prices of those securities to drop, generating large losses in the TBA market, according to two people familiar with the market who weren’t authorized to speak publicly. That’s when the big margin calls started, affecting broker-dealers, they said.

ED&F has faced most of its margin calls from Mortgage-Backed Securities Clearing Corp., according to the people. The MBSCC is a part of the Depository Trust and Clearing Corp.

The TBA market that’s cleared by the MBSCC settles on four days during the month, meaning risky positions can build over time. The clearinghouse uses a daily mark-to-market methodology to ensure users are posting adequate margin, said Tim Cuddihy, a risk officer in DTCC’s fixed-income division. It also uses a value-at-risk calculation for potential changes in value in the future, he said.

The clearinghouses uses a threshold to decide when margin calls are needed, according to Cuddihy. If a portfolio with a starting VAR of $100 million sees a move of more than $20 million in a day, that will trigger a margin call, he said.

In the face of wild price swings, margin calls made by the MBSCC are “significantly higher,” Cuddihy said. There is no plan now to change the margin methodology, he said. “We’ve certainly had no issues with members making their margin calls.”

ED&F Man Capital is the financial-services division of ED&F Man Group, the 240-year-old agricultural commodities-trading house. It has about $14 billion in assets and more than $940 million in shareholder equity, according to the firm’s website.

(Updates with comment from Cuddihy in 14th to 16th paragraphs.)

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