Apr. 5: More information on how mortgage prices work – especially gfees; What is the cost of compliance?

“Hi Rob, I note that recently we’ve had the 3 year anniversary of implementation of  LO Comp / Anti-Steering / Safe Harbor requirements of amendments to Section 226.36 of Regulation Z, which imposed restrictions on loan originator compensation and restricted steering practices by loan originators. As we all know, the Financial Reform Act provides for enhanced financial risks and consequences for investors and servicers in connection with violations of loan originator and anti-steering rules, including but not limited to the following: expanded rescission rights, penalties and damages of 3x loan originator compensation or more, and a defense to foreclosure. Some estimated that for an average size loan, financial risks could be in the tens of thousands of dollars, and in some cases, could approach six figures. So I’m curious, has there been a single consumer claim? And does the MBA or anyone else in the industry compile the cost of the additional regulation that the industry has borne, since it’s all passed onto the consumer?”


Good questions. As it turns out, the good ol’ MBA has information that is useful in its MBA Quarterly Performance Report, and Marina Walsh writes, “Historically, as production volume increased, production expenses per loan decreased because fixed costs were spread over more loans.  But if you compare the production expenses per loan in the fourth quarter of 2011 ($5,118 per loan when average firm production volume was $313 million and 1,431 loans) to …fast forward to two year later… the fourth quarter of 2013 ($6,959 per loan when average firm production was even higher at $367 million and 1,641 loans), there is a difference of $1,841 per loan in expense that needs to be explained.  A lot of that variance must be attributed to compliance and implementation of rules. This data is from about 300 independent mortgage companies and subs of banks.” The reports can also be purchased on MBA’s website by clicking http://www.mbaa.org/ResearchandForecasts/ProductsandSurveys/PerformanceReport.htm – thank you Marina!


Yesterday the commentary discussed some basics of the agency mortgage-backed security market, and how rate sheet pricing has become “flighty” for agency product, especially Freddie and Fannie. Just like the price of a car at the dealer’s lot is determined by several factors (cost of materials, labor, design costs, transportation, supply and demand, profit, to name a few), the price of a mortgage to a borrower is the result of the underlying MBS price, the value of the servicing, the loan level pricing adjustments, lender overhead, supply and demand, and profit margins.


One veteran capital markets person wrote yesterday to remind me that, “A lot of the issue with prices in rate sheets really related to the G-fee. When FNMA / FHLMC increased it to 55 bps, it threw the 4.5% mortgage down into different coupon buckets than those where it had traditionally gone – and this creates a circus on rate sheets.”


This is true. In the move toward increasing their profitability, and at the same time encouraging more “private capital” to enter the market, and let’s not forget Congress using some of the money, the Agencies have increased their guarantee/guarantor fees, now commonly known as gfees, g-fees, or G-fees. These are fees charged by MBS providers (such as Freddie & Fannie) to lenders for bundling, servicing, selling and reporting MBS to investors. The main component of the guarantee fee is charged to protect against credit-related losses in the mortgage portfolio. Think of it as insurance: the more risk, the higher the fee charged. Remember that jumbo loans, and other non-agency loans, don’t have gfees, and thus are not subject to fluctuations in gfee changes.


In “the old days” gfees were less than 25 basis points – now they are far above that. (I vaguely remember high volume lenders having gfees at 10-13 basis points many years ago.) But the lender or borrower do not have to have that fee added to the mortgage rate. Instead, they can “buy it down”, based on ratios published by the agencies or aggregators. Most originators are very aware of other loan level pricing adjustments, such as hits for condos or non-owner occupied units, but gfees, and the buyups and buydowns associated with them, are an integral part of the pricing equation.


But “What drives mortgage rates?” That single question is probably asked more often than any other question capital markets departments may receive. The simple answer is supply and demand for TBA’s, coupled with an assumption of servicing values, and the changes to loan level hits including gfees. The tougher question, and really the question folks are asking is, “What moves TBA pricing, which in turn, moves mortgage rates?” That question involves understanding market dynamics which not only impact mortgage rates, but impact U.S. Treasuries (which shape the yield curve), stocks, corporate bonds, and the entire macro economy at large. Such market dynamics include supply and demand, inflationary pressure, the Federal Reserve, and geo-politics…just to name a few. One common misconception is that if the stock market rallies, bonds sell off, and vice versa. That is not necessarily the case, although the underlying reasons that move equities may tend to move bonds in the opposite direction.


To elaborate, it’s been said that “bond traders toast their marshmallows on the ashes of the economy.” That’s not always the case; however, it’s the prevailing attitude, and a good analogy that what drives equities, seldom drives fixed income (TBAs included). Stock markets and interest rates have an inverse relationship some of the time. It is not “a sure thing” that when investors are putting money into stocks, money moves out of bonds, causing prices to drop, which in turn pushes interest rates higher. It’s easier to explain when you understand that money managers and investors are chasing yield; money has to be working someplace, and the last time I checked savings account rates aren’t covering the cost of inflation.


So sometimes it’s a pretty good bet that when stocks are rallying, bonds are selling off. But looking at market performance over the last few years proves that this is not the case. For the last two years, starting in early 2012, the S&P has steadily improved from 1,300 up to its current level around 1,800. But during the fifteen months bonds were relatively steady, and the yield on the 10-yr waffled around 1.80%. It was only after the Fed announced its intention to phase out Quantitative Easing (QE) and taper off its purchases of bonds that rates started to climb, with the 10-yr moving from 1.80% up to its current level around 2.80%.


Inflationary pressure is a pretty straight forward concept, and an important factor in determining where TBAs are trading. Specifically we’re concerned with the Consumer Price Index (CPI), the Producers Price Index (PPI), and the Average Hourly Earnings rate. In essence every month the government tells us if finished, and raw goods, are getting more expensive, and what the average hourly earnings is for non-farm payroll employees. However, bond investors don’t immediately think about their grocery bill getting larger, or having to pay their tennis coach more, they’re more concerned with the implication. Higher inflation is like kryptonite to fixed income cash flows. More simply, the higher the current rate of inflation, the higher the yields will have to be to off-set inflationary risk. Rates will traditionally go down when inflationary data points to reduced price pressure, and will rise when higher prices are forecasted.


Next to the U.S. Supreme Court, the Federal Reserve arguably wields more power than any government branch; it is the gatekeeper of the U.S. economy. The Fed’s Federal Open Market Committee (FOMC) meets eight times per year in order to determine the near-term direction of monetary policy. By controlling the flow of cash through the economy, the Fed attempts to keep inflation within approved perimeters. During an economic recession, adding money into the monetary system, in order to stimulate the economy, creates a looser credit environment and interest rates will move down. The inverse if true as well. During periods of economic expansion when “too many dollars are chasing too few goods,” the FOMC can contract the economy by pulling money out of the monetary system, and thus forcing interest rates upwards.


To finish up on this discussion with the Fed, the QE program has impacted the demand for MBS (and Treasury securities). It is an easy argument to make that the supply & demand “function” is the #1 determinant of mortgage prices, and the Fed has influenced the demand side of the equation. Hey, if no one wants your purple 1974 Ford Pinto, the price will have to drop until you sell it. But if everyone wants the 2014 Tesla, well, prices will move higher. If there is a huge demand for agency MBS, the prices will increase and rates drop. If demand drops, or might drop, and the supply remains constant, prices will drop and rates will move higher (think 2nd half of 2013). What we are seeing now is that the demand is dropping (the Fed is scaling back QE), and expected to drop more as the Fed stops buying MBS altogether. But supply might be dropping faster – and this is keeping agency mortgage prices relatively stable.


The first half of last week was not a good week for Ellie Mae, or any customers which relied solely on its Encompass services. Documents and disclosures are critical to lenders, to investors who will eventually buy the loans, and to warehouse banks who are releasing funds. To put things in context, Donna Beinfeld (www.donnashi.com) writes, “Failures will always happen and back-up measures should be implemented to prevent high risk to a residential lender for non-compliance of federal (and/or) state law. Two key dates are triggered based on disclosures: #1. Application to initial disclosure represents 3 business days. #2. You cannot close a loan until after the 7 day waiting period based on when the consumer receives the initial disclosures. (Certain exceptions may apply that are considered consumer-related emergencies). About 60% of the medium companies (and most of the smaller companies) use an outside document service provider for closing documents. These vendors have the ability to generate initial disclosure as well. A company should look to their closing document firm for backup on initial disclosure which I believe is a good solution. This would allow a mortgage lender to comply with federal (and state) laws for initial disclosure time frame.”


Donna continued, “The second date that is impacted is the 7-day waiting period from when a borrower receives the initial disclosures. You cannot close a loan until after the 7 day waiting period has occurred. I agree that software failures do not matter when it comes to complying with a 3 business day clock for initial disclosures. Here is an older piece titled, ‘RESPA Reform and the New Good Faith Estimate (GFE) and Form HUD-1 (settlement statement)’: http://www.thebestclosings.com/wp-content/uploads/2013/02/respa_reform.pdf. Lenders must give good faith estimates of mortgage loan costs within 3 business days after the consumer applies for a loan (early disclosure). The closing may not take place until expiration of a 7 day waiting period after the consumer receives the early disclosure.” Thank you Donna!


And lastly, regarding dual/outside employment and FHA, from California Mark S. contributes, “I wanted to share this information below from the HUD ‘Answers’ website. It’s not just settlement services that are restricted, but “financial planning” (at a minimum) as well. ‘Does the FHA restriction on dual employment extend to other financial services related fields? Yes. The dual employment requirement extends to financial and settlement service related fields, such as title insurance and financial planning. For more information, please see the regulations at 24 CFR 202.5(l) on conflict of interest and responsibility. Housing Handbook 4060.1 is available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/handbooks/hsgh. For Mortgagee Letters go to http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/’”. Thank you Mark!



Two older gentlemen have been good friends all of their lives and they both loved baseball, attending many different games together over the course of their lives.

As they were sitting around one day, contemplating life, they began to talk about life after death and one asked the other if he thought they played baseball in heaven. After much discussion they came to an agreement that whichever one of them died first would be sure to come back to earth to let the other one know whether or not there was baseball in heaven.

As it happened a few months later one of them did die. The one left behind was contemplating the loss of his dearest friend, when the friend returned to earth as promised.

The guy who had died told his friend that he had good news and bad news.

He said, “My friend, the good news is that there is baseball in heaven. The bad news is you are the starting pitcher tomorrow”.




(Copyright 2014 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