|
Shocks to the System
Over the past 18 months, there have been a series of systemic shocks to the industry that have created temporary disruptions in many lenders’ ability to originate and sell loans. Currently, the industry is grappling with multiple issues:
- Relationships with TBA broker/dealers are being redefined;
- The demand equation for MBS is shifting away from Uncle Sam;
- Fannie Mae and Freddie Mac are mandated to de-leverage their balance sheets;
- Agency repurchase demands are expected to be increasing;
- GMAC’s 3-D program is terminating;
- Two of the five AOT-style investors have a diminished presence in the market.
Individually and together, these changes in the landscape have far reaching effects on perceptions of counterparty risk, and on the liquidity of mortgages, servicing rights, and mortgage backed securities. In the near term, all of these issues can be expected to have a continuous ripple effect on secondary market execution, and produce volatility in the MBS and whole loan investor market.
As a result, we advise firms to establish and maintain maximum flexibility in the secondary market. The potential to liquidate their originations through every possible execution option should be at the core of each firm’s secondary market strategy.
Secondary Market Volatility
Beyond observing the daily gyrations of the TBA market, there are other observable markers of volatility in the secondary market that may drive execution decisions. The spread between Mandatory and Best-Efforts pricing on an intra-investor and inter-investor basis is one such marker that is constantly in flux for a variety of reasons, and is generally visible to most participants.
Another observable marker of volatility is the actual SRP (Servicing Released Premium) that the aggregators are paying in the market. It takes a little more effort to develop this surveillance, but provides great intelligence about changes in the way investors are operating in the market, as well as their view on interest rates and other factors that influence servicing values. With the right tools, one can take spread between Servicing Released and Servicing Retained executions.The upshot is that these execution spreads come and go. Some days it will be better to sell best-efforts rather than mandatory, or to execute servicing-retained rather than servicing released, or (for banks, credit unions, and REIT’s) to originate for portfolio rather than for sale. Those firms closer to the top of the food chain who may be in a position to portfolio loans, or retain servicing with direct delivery to the agencies should maintain the ability to sell servicing released – including best-efforts, single loan mandatory, and an AOT/Direct Trade basis.
Taking this approach further, firms should develop and maintain relationships with alternate “national” servicing-released investors, who may be considered “second tier” because they offer only best-efforts or single-loan mandatory execution. Regional and local banks and credit unions should also be sought out as alternative investors, especially for the origination and sale of ARMs and Hybrids that are attractive “portfolio” loans in their deposit footprint.
The Future of Fannie Mae and Freddie Mac
We noted in past editions of MIAC Perspectives that the disposition of Fannie Mae and Freddie Mac is one of the most significant wild cards in the industry deck. Proposals regarding the future role of the government in housing finance are still being debated in Washington, and the whole issue is starting to take on the patina of political issues like the continuation of Social Security that get lots of analysis and lip service, but no action.
The de-leveraging of the Agency balance sheets is still slated to occur, so we still expect to see an increase in the supply of MBS in the open market as Fannie and Freddie issue MBS by pooling loans out of portfolio, and we still expect to see a decrease in Agency appetite for whole loan purchases going forward.
We previously noted that the Federal Reserve’s MBS purchase program could provide an offsetting demand to this increasing supply, but as that program is scheduled to terminate at the end of March, the dynamics would appear to favor an imbalance in the supply/demand equation of the secondary market that (barring an increase in the discount or Fed Funds rate) will put upward pressure on long term rates.
Even if all these dynamics happen sequentially, and not contemporaneously, we would expect to see an adverse impact on MBS and Cash Window pricing, as well as greater volatility in the execution spreads we noted above, thus reinforcing the need to be flexible and take what the market is willing to pay.
Best Execution Analysis
Finally, in order to capitalize on the secondary execution that we are promoting, MIAC’s perspective is that a rigorous and comprehensive best execution analysis is essential. This analysis should be done:
- At the loan level
- At least once each day
- Including all applicable investor price adjustments, and
- Considering all possible investor delivery options.
To maximize flexibility and competition in the secondary market, that means modeling and analyzing the execution for:
- All available Servicing Released executions (both Non-Agency and Agency Direct)
- Servicing Retained options for both Fannie Mae and Freddie Mac
- Cash Window execution vs. MBS/PC execution
If your firm is in need of the tools to perform this level of best execution analysis, please give us a call, and we’ll show you how MIAC’s integrated risk management solutions can provide you with the execution flexibility you need to thrive in our constantly changing industry.
|