Apr. 9: Capital markets notes on pricing, hedging, investor behavior, selling tips, etc. – is real time data necessary?
A San Francisco man pays $508 a month to live in a box? What bubble? People do odd things. And some things aren’t so odd, like representing your industry in Washington DC this upcoming week. Mortgage Coach is hosting an executive compliance and marketing roundtable workshop and private dinner with Mitch Kider on Monday April 11th. For those attending MBA Advocacy or in the local area and would like details to attend, email email@example.com. Seating is limited.
Trends and observations of current happenings in capital markets and best execution? You bet there are. Here is Part 1 (Part 2 next Saturday) of a collection of notes from an esteemed group of folks who know how to hedge pipelines. They are in random order – more next week.
MCT’s Phil Rasori had some thoughts on the current slate of investors & how best to sell loans to them. “Over the last two years the mortgage industry has seen an enormous influx of aggregator whole loan buyers. In an attempt to minimize any hedging complications to their secondary departments, many of these new investors initially entered the market by only buying closed loan production on a mandatory basis. Additionally, due to an initial lack of requisite broker dealer assignment of trade approvals, in some cases bid tape execution was the quickest and safest method to rapidly begin buying loan production on a live basis. As an incentive for sellers to negotiate these take outs into their best execution analysis, these new buyers have all provided loan level pricing execution and have not required any large volume minimums. These buyer accommodations quickly succeeded in attracting the majority of sellers to incorporate these additional executions into their investor set.
“A survey of today’s aggregator execution environment will show that the vast majority of whole loan investors not only accept, but recommend the bid tape process as the best method of achieving their highest execution levels. Still, many market participants see bulk bid execution as a fad that will fade in significance as the number of whole loan buyers decline to historical levels. They believe that in addition to cash flow simplification and trading cost benefits, the efficiency of the Assignment of Trade method will outweigh the whole loan granularity benefit of the bid tape.
“At the risk of sounding melodramatic, we believe that the foundation of this thought process sits squarely on the wrong side of history. Due to the minimal amount of information transfer at time of commitment, an efficient Direct Trade or Assignment of Trade program relies on a fairly generic asset. From the buyer’s perspective, pricing factors such as TBA Spec Pay Ups, CRA and MSR Valuation are only accelerating their march to ultimate granularity. A prime example of this is the recent agency cash window differentiation of conventional pricing based on loan balance. Additionally, it is widely believed that the Common Securitization Platform proposed for 2018 will only further perpetuate pricing granularity within the resulting TBA. The basis for this thinking is that the competing agency policies, underwriting and culture could create further variation prepay speeds. As the lender’s ability to efficiently transmit accurate and real time pipeline data to the prospective buyer continues to evolve, we can expect bulk executions to continue to dominate.
“Any truly robust best execution analysis must be able to accurately compare all net flow executions against loan level bulk bid results. This requires the secondary marketing manager to account for more factors in their best execution. The primary additional consideration needed when accommodating bulk bids into a best execution analysis is collecting and adjusting for, accurate market spots. Live executions such as direct trade or agency cash window pricing are generated through live TBA data feeds and automated web crawlers, respectively. However, the bulk bid execution will come from the buyer based on a given market level. Many robust aggregator trading desks will provide these market spots along with their bid tape execution levels. Market adjustments must be then incorporated to properly compare across all execution types. At the time actual commitment these must be reconciled against the live executions as the bid is refreshed with the desk.
“Another necessary consideration when comparing a large number of investor executions is the variation in funding or admin fees. Certain new aggregator and co-issue entrants have set their funding fees substantially higher than historical norms. One note about the investor funding fee analysis, due to the fact that the majority of pricing engines cannot accurately factor funding fee differentials into their scenario best ex, net front end margins between investors will not be consistent. To mitigate this issue, we recommend taking the investor fee differences by product, weighting by that product’s average loan amount and then adjusting your specific investor margins accordingly. While this may be a relatively crude comparison method relative to the preciseness of the back end best ex fee analysis, it will at least provide some directional guidance for your rate sheet with respect to investor fees. While considerations such as market spots and file fees do not come close to exhausting the list of essential factors in a best execution analysis, we use them to illustrate the complexities that are created from the new data driven world of secondary execution. Only when all necessary considerations are accounted for and bulk bid pricing is properly incorporated, can a true best execution actually be achieved.”
Addressing general bond market conditions & how to react to volatility, Andy Mignerey from Capital Markets Cooperative writes, “After 1 Fed rate increase in the last 3,000 days or so, there is finally a change in the air. By now you have honed in on your pull through by channel, branch, product type, loan officer and any other attribute that you find of interest. The recent market volatility from December to now was a good test of the sensitivity of your pipe to interest rates, which allowed you to dial in the slopes of your dynamic pull through models. Hopefully you have been hedging like-for-like so your durations have been perfectly matched. Basis risk is low and life has been pretty good as a secondary marketing manager. There are more aggregators vying for your production than you can manage and your ‘best xing’ to the 3rd decimal for optimal execution. You even survived TRID! Your operations folks have kept turn times to 45 days and with the recent pop in volume at steady margins since mid-January, your feeling even better. Go on, give yourself a pat on the back. What could go wrong, right?
“Well, since February 9th as your pipes continued their growth, the market has felt heavy. You might have noticed more ‘red’ on your screens from the moment you set your production rates until the market closed followed by even lower prices the next morning (so don’t wait till morning to square up!). We all know that volatility increases the frustration factor and hedge cost of your pipes. Markets usually fall elevator shaft style while rising in small increments, but what we currently have is the “death by a thousand cuts” market. That is steady growth of volume at levels lower than when you priced your morning originations. This type of market is not violent or swift on your P&L, but it will have management asking you ‘what happened for the past few months we barely broke even.’ So where did your margins and basis points go?
“So before you scramble for answers to what happened, let’s identify the source and change your daily routine. First, adjust your pricing early and often. Be sure that you know the exact triggers that result in a rate/price change. Have a manual override in your pricing models that allows you to change with the TBA market even if the investors haven’t yet done so. Two, pack a sack lunch. These small intra-day negative movements need to be closely monitored and instantly dealt with to avoid that nagging paper cut. Third, if you’re the only secondary person watching the shop, schedule your meetings after the market closes to avoid missing intra-day market movements. Even better, have the Capital Markets Cooperative help you manage your pipeline.
“Fourth, keep constant track of your daily lock activity and apply your hedges throughout the day (don’t be creature of habit) to match your inflow. Fifth, just because your model updates continuously, you are not saved, it’s the application of hedges at or near the highs of the day while monitoring your lock flow. This is the art of hedging. Be your toughest critic and beat the bogie on a daily basis. Timing is everything. Sixth, stay vigilant of changing market conditions and react quickly to movement and you will avoid having to respond to managements concern about your performance. Have fun in what you do, and do it well. If you are in over your head, get help from the Capital Markets Cooperative.”
Don Brown with Optimal Blue addressed the question that many capital markets personnel ask: is real time data necessary or not? “When technology improves, it takes a long time to bring everyone along. You will always have those on the bleeding edge as well as steadfast luddites. The vast majority will be somewhere between those extremes. The reality is that most of us, to varying degrees, are resistant to or wary of change. We keep doing things the way we know how until we get to a point where either we have no choice or we finally have that epiphany that the new way is worth the pain of switching.
“When I started traveling for business, I would print out maps for each location on my itinerary and carry a stack of paper with me. Over time, with smart phones and navigation apps, such a practice is obsolete. You can still accomplish the goal by printing out maps but why would you not avail yourself of the more efficient process?
“We hear comments from time to time about whether real-time pricing is necessary for either the hedging or the best execution and loan allocation processes. The reality is that it is not necessary. Just like the map print outs mentioned above, you certainly can accomplish the goal of managing risk and selling loans without real-time data.
“Heck, the secondary markets existed, and functioned well, years before there was even reasonable market transparency. A good friend of mine told me a story once about a secondary marketing conference during the Black Friday event of the late 1980’s where once news of the dramatic market movement of that day made its way to the ski resort where they were no doubt deliberating on some serious mortgage issues, everyone went scrambling to the bank of pay phones to get in touch with someone who could figure out their position and adjust their coverage. Did people lose money on that day? No doubt. However, they all were playing by the same rules and were under the same technological constraints.
“The good news is that technology and market transparency both have improved significantly since that time. Those improvements have reduced greatly the nasty consequences that result from such technological and transparency deficiencies. And we will continue to see even more improvements which, in turn, will further minimize market inefficiencies and their consequent arbitrage opportunities.
“The point is that if a technological innovation is available and that innovation will allow you to have more current information at the point of decision, why not take advantage of it? If real-time data is not necessary, then the question becomes how stale is too stale. Is it ok if your eligibility information is 24 hours old? 1 week old? More? How about pricing data? Is data from one hour ago stale? One day ago? Greater?”
Don finishes with, “So I ask you, if real-time data is available to you when you are making a decision to adjust your position or to commit a certain loan or group of loans, why wouldn’t you use it?”
(Thank you to Carol for this one!)
An accountant and a lawyer were lying on a beach in Hawaii sipping Mai Tais.
The lawyer started telling the accountant how he came to be there.
“I had this downtown property in Memphis that caught fire and after the insurance paid off, I came here.”
The accountant said, “I had a downtown property, too, in Miami. It got flooded so here I am with the insurance proceeds.”
The lawyer took another sip of his Mai Tai, and then asked in a puzzled voice, “How do you start a flood?”
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