Apr. 16: Note on trends in capital markets, successful CRA lending, and the DOJ/Freedom Mortgage settlement

Scott R. writes, “Your ‘living in a box’ link had me remember the Seinfeld episode when the Japanese slept inside of Kramer’s dresser drawers.”


Maria Zywiciel kindly wrote in pointing out she has “recently written an article for Mortgage Compliance Magazine (p. 32) – ‘Ten Tips to Successful CRA Strategy.’ “Enacted in 1977, the Community Reinvestment Act (CRA) sought to address redlining: discriminatory credit practices toward individuals in low to moderate income neighborhoods. Given the penalties for non-compliance, banks that accept FDIC-insured funds remain vigilant in ensuring their business practices serve the communities from which they receive deposits. As ubiquitous as CRA is with lending practices, it is frequently misunderstood…”


Without the disposition of the assets (mortgages) in the secondary market, whether it is in portfolios or sold to investors through whole loan or security sales, the primary market would find it difficult to function. So it is important for folks to know the trends in capital markets. Several hedging companies had contributions last week, and there are more this week.


From Compass Analytics’ David Ellenberger comes, “A consistent theme we are hearing is that despite the rally over the last few months our clients are not seeing the expected pickup in production and margins. Our internal measure of primary/secondary spread is at a two-month low, indicating tighter margins, and we are seeing production volume down 20% from the February peak. Only 15% or our clients are overcapacity, with the rest at or below capacity. Partly, this may be due to seasonality factors in the slower winter months, but we believe that originators are coming to terms with a more competitive origination business with lower margins and higher fixed costs, due in large part to higher headcounts in compliance.


“In this kind of environment, where each basis point matters, we emphasize the same types of things to our clients that we always emphasize – best execution, upfront focus on clean data, and accurate capture, reporting, and tracking of secondary and accounting performance. We remind clients to remain vigilant in challenging their best-execution analysis, counterparties and delivery methods. We encourage discipline with our clients to pay close attention to their daily accounting and secondary numbers so they are always confident in their performance and to avoid surprises at loan sale, purchase advice reconciliation or month-end accounting.


“Taking it a step further, we are stressing the importance of tracking and actively managing originator performance. If clients have been putting-off acting on branch, broker or seller reviews, we are suggesting that now is the time to dive deep into originator fallout and hedge costs to improve secondary performance. Such analysis continues to surprise clients when they realize how much overall performance is impacted by lower-performing originators. Finally, we are strategizing with secondary departments in deploying originator scorecards through compensation, pricing and other incentives to improve overall performance.


“In summary, the challenging environment, where lower rates do not necessarily equate to higher volumes and fatter profit margins, encourages the same secondary remedies and good habits that ultimately provide clients competitive advantages across all market conditions.”


I received this note from Chris Bennett with Vice Capital Markets. “Rob, one of the biggest things we stress to firms in proper position management relates to the accuracy, granularity, and dynamism of their pull-through modeling. Everywhere you find a statistically significant correlation between an element or characteristic of a loan and its performance should be part of your modeling. Not just basics like branch or division, product type, loan purpose and obviously market movement, but things like loan size also come in to play and should be accounted for.  If rates drop .250%, it’s going to have a lot bigger effect on the pull-through expectation of your $300k+ loans than it will on the sub-$140k part of your pipeline. One other major factor that is often overlooked is that your model needs to not just look at the phase/status/milestone of a lock, but it needs to also evaluate that status in the context of the application’s progress through its lock period. A lock that has not yet been submitted to underwriting that was locked last week and expires in 50 days has a dramatically different pull-through expectation than a lock that expires next week and has never been submitted. They have the same status, but very different closing expectations.


“Another thing we often notice when new companies come to us is that while they have good core best execution modeling, it misses some of the finer points that need to be accounted for. For example, if a loan is 7.2bp better at investor A compared to investor B, but investor A has a funding fee that is $150 higher than B, is that really best execution for that loan? When doing a retained versus released analysis, are you giving any financial credit to the cost efficiency of selling retained? When comparing AOT executions to bulk bids, are you taking into account any transaction costs in removing the associated hedge versus being able to assign an existing trade for delivery? Are you getting all the gains that can be had from forming GNMA II custom low balance pools or even just swapping multi-issuer pools to get a payup for a new issue stip?   The explosion of co-issue deals in the last year or two has really opened the door for a number of companies that want to reap the gains and efficiencies from pooling without having to sacrifice cash to do it. There are a lot of little things like this that really add up – even just squeezing out or saving 4bp brings in an extra $400k a year in profits for an $85mm a month originator. Real dollars to be sure.”


From Mortgage Capital Management (MCM) Ron Kiuttu writes, “The month of February could have proven to be a tough month for profitability for many mortgage bankers. Higher levels of volatility were prevalent through most of the month. Prices of mortgage backed securities rallied to recent highs during the early part of the of the month causing many locks from January to either leave and go elsewhere for a loan or to come knocking at the lenders door to request a lower rate. Either case would lead to a lower profit margin. In addition, execution of selling loans was less favorable because basis spreads widened out. That is a double whammy to a mortgage banker’s profitability.


“During this period of time the move higher in prices was accompanied by increased volatility that did not begin to subside until the end of the month. The fear and uncertainty in the market led mortgage investors to be cautious in pricing out to the street and in their bidding of bulk packages. Many mortgage bankers only think of basis risk as hedging with a different instrument than their standard TBAs that match the note rate of the loan. They believe that as long as they are hedging with matching TBAs there is no basis risk. Yet, when there is volatility and investors do not price in accordance with the movement in the TBA market, this is basis risk.


“To illustrate the basis risk, a look at a chart of recent investor average pricing for a 3.75% note rate versus the securitized 3.75% note rate in a FNMA30 3.0 coupon at matched initial pricing points. Basis spreads moved daily. In addition, the volatility movement during the same period of time is telling. During the periods of high volatility from February 1st to February 24th, there were 7 days where spreads were worse by 20 basis points or more. One can also see that when volatility subsided, investor price levels improved in relation to securitize pricing. Couple basis risk and volatility together with increased fall out/renegotiations and reduced profit margins will be the result.


“At Mortgage Capital Management we promote monitoring basis spreads between investor pricing and securitized TBA pricing, and market volatility to determine if it is a good time to sell loans. In addition, close daily monitoring of potential loan fallout is a critical daily activity. Mortgage Capital Management provides tools and daily coaching to assist in managing these risks. Management of these risks will lead to more consistent marketing gains and prevent the double whammy.”


Focusing on pricing methodology, Rob Branthover from MIAC has noted that, “The recent changes to Fannie Cash pricing which allows originators to earn “spec” pool pay-ups for low balance pools have made a noticeable difference in execution. To take advantage of the better pricing, MIAC needed to invest some time in building out the pricing models to support them.  Traditionally, spec pool pay-ups were structured as an adjuster (as they still are on the MBS side) that would be applied to base pricing. With the recent changes, we now need to download discrete pricing for each loan size. What used to be a single pricing download, is now ~ 6 for each product group, and there are limits on how much cash pricing can be downloaded at a time.  These limitations necessitate multiple downloads across multiple servers simultaneously.


“MIAC has automated this within the Marketshield application for all of our customers. To use the new pricing surfaces, MIAC breaks out each category to provide the correct MTM. Fortunately, these are standardized pricing models, so the changes need to be made only once. For customers who are heavy originators of conforming high balance loan, the recent changes may hurt their all-in execution, as Fannie requires each pool to have a maximum of 10% high balance. This means that each new low loan balance spec pool potentially reduces the denominator, so the seller’s ability to optimize this execution becomes more difficult.  Freddie on the other hand, measures the 10% delivery threshold on an aggregate basis, requiring committed pools include less than or equal to 10% conforming high balance loans for each month across all commitments.


Rob B. closed with, “Overall, the biggest detriment to the management of this process with Fannie Mae is the time it now takes to commit loans.  What used to take 5 minutes to take down a few commitments for $10m in sales now can take 20-25 minutes to take down a dozen or more commitments to satisfy the requirements for the pay-ups while adhering to the 10% limit on high balance concentration. In the end, the pay-up is worth the effort, but like most things in life, one needs to focus on making the process as efficient as possible and Fannie appears to be committed to doing so as well.”



And lastly this regarding the latest from the DOJ: “Rob, with the latest victim of our government’s additional tax on our industry being Freedom Mortgage for $113 million, why would anyone want to take the chance with originating FHA loans?” Well, it is not exactly a tax. It is labeled a settlement under the False Claims Act. And Freedom has an official response that I will include Monday. But everyone now is doing all these loans perfectly, right? And passing the costs of doing a perfect loan on to the consumer, right? And only too happy to willingly step into whatever voids may be created by any lender, like Chase, willing to scale back on FHA lending, right? Certainly they are lucrative loans and plenty of lenders are willing to “take the chance.” Interestingly these fines pertain to loans done many years ago…



Thank you to Janet S. for this one.

A father walks into the market followed by his ten-year-old son. The kid is spinning a 25-cent piece in the air and catching it between his teeth. As they walk through the market someone bumps into the boy at just the wrong moment and the coin goes straight into his mouth and lodges in his throat.

He immediately starts choking and going blue in the face and Dad starts panicking, shouting and screaming for help.

A middle-aged, fairly unremarkable man in a gray suit is sitting at a coffee bar in the market reading his newspaper and sipping a cup of coffee. At the sound of the commotion he looks up, puts his coffee cup down on the saucer, neatly folds his newspaper and places it on the counter. He gets up from his seat and makes his unhurried way across the market. Reaching the boy (who is still standing, but only just) the man takes hold of the kid and squeezes gently but firmly. After a few seconds the boy coughs up the quarter, which the man catches in his free hand.

The man then walks back to his seat in the coffee bar without saying a word.

As soon as he is sure that his son was fine, the father rushes over to the man and starts effusively thanking him.

The man looks embarrassed and brushes off the thanks.

As he’s about to leave, the father asks one last question. “I’ve never seen anybody do anything like that before – it was fantastic – what are you, a surgeon or something like that?”

“No” the man replies, “I work for the IRS, getting people to cough it up is my business.”





(Copyright 2016 Chrisman LLC. All rights reserved. Occasional paid job listings do appear. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Rob Chrisman.)

Rob Chrisman