MIAC Perspectives - Federal Conservatorship of Fannie Mae and Freddie Mac (Special Edition)
Sep 10th, 2008.
Secondary Solutions Group Commentary
Generally, during the course of the “time out” phase of the Agency Conservatorship, we expect minimal disruption to the economics and mechanics of originating and selling loans into the secondary market. The focus of those who crafted the terms of the conservatorship is clearly on preserving and enhancing the liquidity and commitment of global capital to the U.S. housing market. By recognizing that the instrument of that liquidity is the agency mortgage-backed security, the federal government has ensured that the pipeline for delivering those funds remains open and generally unaltered for the time-being.
While we generally expect a “business as usual” environment on a macro-level, there are nuances to the terms of the conservatorship that may produce micro-level changes, as well as some macro-level changes to the landscape of the industry in the near-term. While we await clarity on the implementation of these nuances, below we have identified a few areas for continued discussion, observation, and focus to determine what might happen.
The impact on the environment for mortgage originators depends largely on how the conservator wields the powers that it is granted in assuming the day-to-day operations of the two companies. Their goal as conservator is to restore the companies to self-sustaining and independent status, and they not only have the authority to enter into new contracts, but also the authority to repudiate and cancel contracts between the agencies and its partners in the primary and secondary market.
The application of this authority to cancel contracts is subject to a determination by the conservator (in its sole discretion) that 1) the conservator’s performance under the contract is burdensome; and 2) that cancelling the contract will promote the orderly administration of the affairs of the regulated entity. This authority extends to contracts that the agencies entered into for the forward purchase of mortgages, mortgage-backed securities, or any interest in a mortgage loan or groups of mortgage loans, including mortgage servicing rights.
The possibilities for how this could take shape include cancellation of negotiated master agreements and MBS contracts that have more favorable terms than their generic versions. It’s no secret that for years the agencies have been trading lower guarantee fees and aggressive credit variances for volume commitments from the largest servicing aggregators and securities issuers. The guarantee fee arbitrage made available by the agencies to these firms is partially responsible for reinforcing the position of these aggregators in the market, and assisted the consolidation of the servicing and MBS/PC issuance by those firms.
We believe that the greatest impact upon the landscape of the secondary market would be produced by the conservator determining that these negotiated transactions are burdensome and counter to their mission. We are not arguing that this is (or will be) the case and we think that if this does happen, the overall impact would be marginal because:
- Most independent mortgage bankers simply don't have the capital or operational capacity to sell servicing-retained (Regulated Financial Institutions being the obvious general exception).
- The reduction or elimination of the aggregator's guarantee fee arbitrage would reduce the relative total pass-through price to correspondent sellers by approximately 20 bps at most – a material amount, but not enough to drive most mortgage bankers to retain servicing;
- A flatter guarantee fee playing field (whether higher or lower than the current levels)
- could produce more competition for the aggregators by others who have the financial and operational wherewithal to retain servicing, and
- may encourage the development of more aggregators;
- These new and current aggregators will need to analyze precisely the relative pricing of selling MSRs Released or Retained;
- Although any increase in guarantee fee experienced by the aggregators may affect the SRP they offer, their position in the market will continue to be reinforced by the need for mortgage bankers to sell servicing-released;
- The prevalence of 'credit overlays' recently imposed by the aggregators has tended to offset or eliminate any credit variances the aggregators obtained previously – needs to be reworded with reference to eligibility engines;
- Unless the execution on the Agency servicing-released business improves substantially (a more weakened probability now), the ability to avoid aggregator credit-overlays provides the only real (albeit marginal) incentive for independent mortgage bankers to deliver directly to the agencies.
- Overall, the well capitalized middle-tier mortgage originators would stand to benefit the most from the elimination of the aggregator’s guarantee fee and credit arbitrage, helping somewhat to disperse the agencies’ counterparty risk.
Conclusions and recommendations:.
- The general pyramid structure of the secondary market will remain in its current form.
- Aggregators will continue to dominate the accumulation of servicing and issuance of securities;
- Mortgage originators who sell servicing released need maximize revenue by insisting that multiple aggregators compete for their business;
- The Assignment Of Trade (AOT), (aka Mandatory or Direct Trade), execution with multiple aggregators produces the best-execution choices;
- An increased focus on proper valuation of the MSR in the pipeline will enable mortgage companies to better optimize these new best-execution choices;
- Those who can get agency approval for direct sales should do so to provide flexibility around the credit-overlays imposed by the aggregators;
- Mortgage bankers should adopt a “portable pipeline” strategy through use of multiple AOT, Mandatory or Direct Trade executions instead of Best Efforts;
- Benefits for mortgage bankers choosing the “portable pipeline” strategy include:
- a significant competitive advantage over those who don’t (up to 50 basis points in price);
- far greater flexibility in their rate-lock policies;
- enhanced ability to protect their pipelines in a market rally;
- avoiding investor pull-through issues associated with best-efforts commitments
- mitigating their overall investor and product risk;
- Mortgage bankers choosing the “portable pipeline” strategy must hedge market volatility to mitigate impact of market volatility on the value of the pipeline and inventory;
- MIAC’s MarketShield™ and WinOAS™ software and Secondary Hedge Advisory service simplifies the best execution and hedging activities so mortgage bankers can achieve higher revenue while mitigating the impact of market volatility on the P&L;
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