Apr. 2: TRID question from brokers; the industry’s role of MORPAC; primer in MBS prices, the 10-year, and borrower’s rates; cool bald eagle cam

Say what you want about bald eagles, or where these Aves reside; this live cam is pretty cool: http://dceaglecam.eagles.org/. (Page down once or twice to see the action.)

For many “networking” means rubbing elbows at the social events of a conference. Regarding changes in networking, Bear2Bull’s Penny Pearl writes, “Online networking has changed the way we do business—forever.  Modernizing the way you find your next great producers, partners, leads and referrals is online, so are you considering innovative ways to build your relationship pipelines? Read more.”

Five months after the mandatory implementation of “Know Before You Owe” there are still plenty of questions – no one wants to run afoul. For example, just yesterday I received this note: “Pre-TRID, GFE disclosed broker compensation as we know it. Post TRID, it is my understanding, most to majority of wholesale lenders do not require disclosing the compensation with an additional addendum like the mortgage broker fee agreement for LPC loans, while some seem to interpret a different approach. While it seems most do not require the form, there are a few lenders I’ve discovered that require an initial mortgage broker fee agreement (or some similar version) with the loan submission, to be signed by the broker only.”

The note went on. “The extra conservative approach is to require this same MBFA signed by the borrower (with a position that it is either required or ethical to disclose MBFA with compensation percent and dollar amount). Do you feel or know if this is required on lender paid (wholesale to broker channel), where the rebate/credit covers compensation at registration and or lock? A prior lender (post TRID) has a MBFA signed by broker only. Curious of any feedback with requiring borrower to sign MBFA on lender paid (wholesale to broker).”

To my knowledge there is no requirement for a broker to fill out a mortgage broker fee agreement federally. Maybe some state has an additional requirement however as a general practice, the Loan Estimate is the document the consumer needs to assess their loan. For broker-originated loans, lender paid compensation (if covered by rate credit on loan) does not need to be shown anywhere on the LE. This is a very big positive for mortgage brokers, who for years have been at a disadvantage (or non-level playing field) compared to bankers. With the new LE and other positive changes for mortgage brokers, wholesale management reports to me that they are seeing a huge number of new brokers come back into the market by leaving the retail branches and large banks: the lender paid compensation amount is shown on the CD as POC by lender.

And industry vet Keith Bilodeau, SVP of Freedom Mortgage’s Wholesale Division, advised, “At Freedom, unless a Broker Fee Disclosure is a specific state or municipality requirement, we don’t require it. I think it’s important to remember that part of the reason the LE does not require the broker to disclose the Lender Paid Comp in a fee breakout, like they did pre-TRID, was due to the industry complaint about an un-level playing field. The TRID-LE rules were designed to create the level playing field between brokers and lenders on the front end of the transaction. The CD would display the specific lender/broker fee breakdown so ultimately the brokers direct revenue (LPC) is disclosed.”

At time readers have asked me why, if their company belongs to the MBA, they should join and/or contribute to MORPAC. Rather than me merely say, “Cuz it helps the business” I turned to Jamie Korus, the president of Alliance Home loans. She replied, “The MBA does many things for its members and industry as a whole. The membership dues companies pay is needed to provide the foundation for staff to provide the many facets of support that MBA has to offer. These dues allow for education to be developed and offered to constituents of the industry. They allow for the governance of the association where members and participants of the industry are able to have their voices heard and their concerns flushed out through the research and advocacy done by the staff. The research department is one of the best in the industry providing information to help direct the decisions of its member companies and also to provide vital industry data to consumer groups, policy makers, media, etc. The dues allow for major conferences to be held where members can learn, become more engaged in MBA programs and network. The staff that is employed through membership dues allow for a strong and comprehensive lobby team to fight for the members’ interests with policymakers. But your individual advocacy is a key important to the work MBA’s lobbying team does.

“MORPAC is a way for every individual who works in real estate finance to take part in advocating for their career and the protection of our industry. MBA’s full-time lobbyists work on a daily basis to connect with, and educate policymakers. Their efforts act as a huge voice for mortgage bankers, and MORPAC plays a role in that process. MORPAC helps elect and re-elect candidates to Congress who have an understanding of the real estate finance industry and who are supportive of our profession. Because MORPAC is a federal PAC, it can only accept individual contributions; funds cannot be used that are providing from MBA or any other company including member companies. Through fundraising from people who work in, and earn money from real estate finance, the PAC is able to help those policy makers that are friendly to our industry be reelected through financial support.” Thank you Jamie!

Switching gears to the factors that help set mortgage rates for borrowers, Brent Nyitray, Director of Capital Markets at iServe, contributes, “The Treasury is the base rate that everything is related to, just the way the base rate sheet is. The additional yield (the OAS spread) is basically the big LLPA that investors add to MBS yields to compensate them for the additional risk (negative convexity). So MBS pricing is based on Treasuries and OAS the way a loan is based on the rate sheet and the various LLPAs.

“Regarding Treasuries and the 10-year T-Note: Ginnie Mae MBS are guaranteed by the government, as are Fannies implicitly. The difference between the 10-year and the MBS is not due to credit, it is due to negative convexity. Most know that rates go up when bond prices go down. Most also know that duration is a measure of the expected life of a bond but it is also a measure of how sensitive the bond is to interest rates. For a treasury security, as rates increase the bond price falls, however as it falls, it becomes less and less sensitive to further interest rate increases because duration is shortening. Duration can be thought of as the weighted average time it takes to get paid back.

“So if one owns a 10-year T-Note, it might start with a duration of 9 years (to pick a number). As rates increase, the duration will decrease to, say 8 years. This is because the coupon payments become larger relative to the bond price (at say 90) versus par.  As rates fall, the bond price goes up, and it becomes more sensitive to further rate decreases as rates fall. Opposite effect: Interest payments become lower relative to the bond price (as it goes from par to 105). So maybe the duration of the bond increases from 9 years to 9.5 years (assuming the bond is non-callable). So, for a typical bond, duration (or sensitivity) decreases the more wrong you are and increases “the more right” you are. This is called positive convexity.

“Now think about mortgage-backed securities. What happens when rates rise? Bond prices fall, however your duration (and sensitivity to further rate increases) goes up (not down) due to changing prepayment assumptions.  Rates rise – refis go away, and prepayments fall. So your 10-year duration increases to 13 years, making it more sensitive to further rate hikes, not less. On the flip side, as rates fall, refis increase, and your duration falls from 9 years to 6 years as everyone refis out. This makes the bond less sensitive to further rate hikes.  Negative convexity means duration (or sensitivity) increases the more wrong you are and decreases “the more right” you are.

“That dynamic is referred to as OAS (or option-adjusted spread) and explains the premium that MBS investors require over treasuries. It also explains the science of pipeline management… As rates increase -> fallout decreases-> need more TBA exposure to hedge -> sell low. As rates decrease -> fallout increases – you need less TBA exposure to hedge -> buy high.”

Brent’s note wrapped up with, “So with hedging a bond with positive convexity, you are buying low and selling high. When hedging a bond with negative convexity, you are buying high and selling low. That risk/behavior has to get priced in, and that explains the difference. Not credit.”

Bobbie Brown is currently with Franklin American but was previously “a mortgage backed security specialist for the then-mighty bond house of Salomon Brothers and as a member of the Salomon Brothers training class” learned bond math by hand. “If anyone wonders why the 10-year Treasury is important, here is additional insight. For a moment, consider that I am a large institutional investor, who wants to purchase a chunk of 10 year Treasuries, bought at par (100) with a coupon of 2.25. The Yield to Maturity (YTM) is 2.25%, if held for the entire 10 years.

“When interest rates rise, the 10-year treasury will decrease in price. If the 10-year note originally yielded 2.25%, and rates are now 3%, as an investor, I will want to pay less then par (100), say 93, so that the instrument I am buying is closer to 3% in YTM, because I not only have the semi-annual payments of 2.25%, but I also have the increase in principal of 93 to 100 if I hold it to maturity. When interest rates fall to where, for example, 10-year rates are now 1.5%, I would have to pay a premium of say 106, so that at maturity I not only have the 2.25% but also the 6-point decrease in price from 106 to 100, to bring my Yield to Maturity in line with the current interest rate of 1.5%.

“MBS have a similar inverse relationship. When interest rates rise, prices go down. When interest rates fall, prices go up. So why is there NOT a DIRECT correlation between the 10-year T-Note and MBS? When the standard mortgage of 30 years goes into a pool of mortgages, the average time a homeowner holds a mortgage before selling or refinancing the home is 7- 10 years. Unlike a 10-year Note with a set maturity of 10 years, however, the duration of a pool of mortgages changes, depending on whether interest rates are rising or falling. Why? When interest rates drop, what happens? People refinance their mortgages, and so the original mortgages in the pool pay off, so I own that pool for a shorter amount of time. When interest rates go up, people hang on to their original mortgage (unless selling their house), so I own the pool longer. In summary, a Treasury has a finite maturity, whereas Mortgage Backed Securities have a variable maturity, depending on whether interest rates are rising or falling.

“On a mathematical side note, even duration (Macauley’s, Modified, or Effective) is not entirely accurate, since it is a straight line calculation. More accurate is the 2^nd derivative, which takes Convexity into account.” Thank you Bobbie!

A man and his wife were awakened at 3AM by a loud pounding on the door.

The man gets up and goes to the door where a drunken stranger, standing in the pouring rain, is asking for a push.

“Not a chance,” says the husband, “it is 3:00 in the morning!”

He slams the door and returns to bed.

“Who was that?” asked his wife. “Just some drunken guy asking for a push,” he answers.

“Did you help him?” she asks.

“No, I did not; its 3AM in the morning and it’s *&^% pouring rain out there!”

“Well, you have a short memory,” says his wife. “Can’t you remember about three months ago when we broke down, and those two guys helped us? I think you should help him, and you should be ashamed of yourself! God loves drunk people too you know.”

The man does as he is told, gets dressed, and goes out into the pounding rain.

He calls out into the dark, “Hello, are you still there?”

“Yes,” comes back the answer.

“Do you still need a push?” calls out the husband.

“Yes, please!” comes the reply from the dark.

“Where are you?” asks the husband.

“Over here on the swing,” replied the drunk.

Rob

(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.)