Dec. 19: Non-QM and Agency trends in the secondary market; letter on borrower communication

Numbers are amazing things. What would we do without them? On the small scale, there are people who will swear that they’ve never touched the 4, 5, 6, 7, 8, or 9 keys on the microwave oven control panel. On a large scale, out of the trillions in mortgage loans outstanding, a very large share are securitized under the Ginnie, Fannie, and Freddie MBS “umbrellas.” (You can do your own research using the link; the Excel file is a good place to start.) The GSEs, aka Agencies, occupy a critical piece of the mortgage food chain, both in the primary and secondary markets. Without the demand by investors to own mortgages, and the securities backed by them, our industry would be dead in the water. But non-Agency loans, like non-QM and jumbo, are also securitized, with varying risk profiles. Let’s take a look at both the primary and secondary markets below.

The ever-changing borrower

Lenders are certainly grappling with all the ramifications of the pandemic. Some are partnering with vendors to help clients; some are offering innovative solutions. Yesterday’s commentary talked about recent research from Spruce and is very much in line with what research on the industry is finding: Buyers are open to technology helping to speed up the process and are frustrated it is taking so long.

Along these lines, I received a note from Ed Abufaris of SupportLink3 (SL3), a financial services consultancy, and Bellomy, a full-service market intelligence firm, who have partnered to reveal pandemic implications for mortgage lenders. “Rob, we’ve seen quite a sea change in the home-buying climate amidst the pandemic. Armed with questions inspired by SL3’s mortgage banking experts, Bellomy surveyed more than 1,000 members of a proprietary panel Bellomy has been monitoring since March. The research shows not only who’s struggling, but also how shifting preferences in a key demographic create an invaluable opportunity for mortgage lending companies… At least the ones who are willing to adapt.

“We’ve found a climate and generation ripe for home purchases. Interest rates have been at an all-time low since COVID-19 began. Unemployment rates have seen all-time highs, families have had to quarantine inside of their homes, and many businesses have been forced to close. At the same time, CNBC cited a 4% increase in home sales from September to October and a 26% increase since last year. Bellomy’s data shows that nearly two-thirds of the population have not yet bought a new home, financed, or renovated this year; and COVID-19 is impacting the home-buying journey, especially for one forward-thinking group – Gen Y/Z.

“43% of Generation Y and Z respondents said the pandemic has changed the way they think about purchasing a home. Of those that have already gone through this process since the pandemic began, 48% said the loan process was extremely difficult for them. On top of that, about half of those in younger generations report that the pandemic has impacted their lender’s ability to assist them. Overall, Gen Y/Z, the next generations of home buyers, are ready for changes in the mortgage process. Although this change is driven by younger consumers, Gen X and Boomers also have mixed preferences regarding the best way to communicate during the home-buying journey: two-thirds of Gen Y/Z and 59% across all generations said they would move to a contactless loan process if it were made available to them. A closer look at each point in the journey, however, reveals that there is no one-size-fits-all approach.

“We’ve seen shifting preferences, expedited by the pandemic and solidified by Gen Y/Z. Each individual touchpoint on any given journey represents a customer need and opportunity to address that need. Bellomy identified and asked respondents about the following touchpoints along a homebuyer’s journey: General questions and inquiries, initial application, assessing options, home selection, closing, and post-closing communication.

“For each touchpoint, respondents were asked to select which method they most preferred for communicating with their lender: in person at a branch, in person during a home visit, telephone, text-based chat, video chat (e.g., Zoom), or email. A new trend seems to be emerging along the home-buying journey. As home purchases continue to rise, Gen Y/Z may be looking for lenders who provide non-traditional approaches. This up-and-coming group has the strongest preference for digital methods compared to their Gen X and Boomer counterparts. With channels like text and video chat emerging alongside email, this generation is becoming more accustomed to engaging digitally rather than in person, with one exception.

“Although no ‘one-size-fits-all’ communication approach fits everyone, email was the overall preferred touchpoint for five out of the six touchpoints. When it came to closing, however, even 23% of Gen Y/Z respondents preferred to seal the deal in person compared to the 18% who preferred email. This means that although there is evidence to start catering to potential buyers’ digital preferences, you can’t end your lease just yet. There’s a time and place for everything, and the place, when it comes time to sign, is in person, behind closed doors.”

The note finished up with, “Lenders should know that between a new generation of homebuyers here and on the horizon, a pandemic that’s shifted work and home environments, and the most attractive interest rates in history, it’s evident that the landscape for mortgage lending and corresponding communication is shifting. This highlights the importance of having an omnichannel approach to ensure you are reaching the right clients in ways they want to be reached. Companies need an omnichannel/cross-channel content strategy to improve their user experience and drive better relationships with their audience across points of contact. Rather than working in parallel, communication channels and their supporting resources are designed and orchestrated to cooperate. At the end of the day, it comes down to knowing who your customers are, what they want, and what you can do to optimize their experience every step of the way.” (For more about the research, access the full report or watch the findings presentation.)

Deals in the secondary market, with a little Agency and non-QM history lesson

In September 2008, the U.S. Federal Housing Finance Agency (FHFA) used its authority to place Freddie Mac and Fannie Mae into conservatorship in response to a substantial deterioration in the housing markets that severely damaged each enterprise’s financial condition and left both of them unable to fulfil their missions without government intervention. Since then, the GSEs have been the subject of numerous reforms. Those reforms, in conjunction with rising housing prices, have helped improve the profitability of the GSEs, so much so that they have paid over $300 billion in dividends to the Treasury. Progress on reforms and improving profitability have led to calls to move the GSEs out of conservatorship. While that is unlikely, what could happen is a move from an implicit guarantee to an explicit full faith government guarantee on U.S. agency MBS.

Fannie & Freddie during the crisis were a couple of the biggest “take outs” for Alt A and Neg-Ams and other products. Remember that F&F were losing far in excess of their capital but were considered “too big to fail.” Freddie’s regulator was OTHEO, part of HUD. Personnel-wise, James Lockhart shifted into the FHFA at the tail end of the Bush Administration.

Currently the U.S. Treasury is the largest investor in the Agencies, owning about 88 percent of the stock of each (nice gain!), and consequently both saw a huge inflow of cash. But “recapitalize and release” has been a key topic for several years, helped last year by the Agencies ability to retain profits which has encouraged their independent shareholders.

MLOs know that there is talk that F&F may start offering gfee, buyup/buydown grid deals, or may also shrink their footprint through pricing moves or eliminating products. The “level playing field” where IMBs can compete with depository banks, or small compete with large, may go away. In recent years execution has been roughly equal, helping Independent Mortgage Banks (not owned by a depository).

To release Freddie and Fannie requires the Secretary of Treasury’s approval, which we’ve been reminded of in recent weeks with conjecture of something happening prior to Inauguration Day. The industry, and homeowners, predicted significant disruption risk. Analysts wondered if Agency MBS would be devalued, or down-graded (AAA to AA could be significant). The GSEs don’t have enough capital now to be released, so a consent order was discussed in the media which could have been drafted so that they would be released under the order which restricts them (no new products). The release would have reduced their footprint. Fortunately that talk has been put to rest, primarily through the efforts of our Mortgage Bankers Association.

Currently there is no extensive private MBS market currently, despite non-QM and jumbo products being offered in the primary market to borrowers. In fact, some favor government control of non-Agency MBS. And so the vast majority of the residential lending industry’s volume is government related (Freddie Mac, Fannie Mae, FHA, VA, and USDA, along with various bond programs). But that doesn’t mean non-QM loans have vanished, and in fact that segment of the industry has bounced back somewhat from a disastrous March earlier this year when liquidity dried up and many lenders were left holding non-QM that couldn’t be sold at decent prices.

It was a similar story to 2008, when risk managers were on the hook for representations and warranties (R&W) exposure, or repurchase exposure. The issuer of a mortgage or mortgages is sometimes required to repurchase the loans and make whole the investors if the loans are found to breach the seller guidelines, per R&W agreements. Many banks and nonbanks had not fully accounted for this risk on their balance sheets.


Milliman released a paper about the repurchase risk for non-QM mortgages, discussing how the primary causes of the accumulated repurchase exposure of the 2008 financial crisis were lax underwriting standards and a lack of proper oversight and quality control in the loan issuance pipeline. In the wake of the last financial crisis, the whole industry tightened its processes and controls surrounding non-QM. Fortunately, there is now increased hindsight understanding of the risk, guidance, risk management processes and clarity surrounding regulatory requirements.


In addition to representation and warranty issues, counterparty risk and liquidity risk are making lenders reluctant to participate in non-QM issuance. Often, every single loan in a transaction will be reviewed, and it can be very expensive for the issuer to have loans repurchased due to breaches in the underwriting process.

Some lenders issuing non-QM have overcome this by setting capital aside as reserve estimates on an expected basis for each mortgage issued. Other lenders choose to purchase insurance against the repurchase or indemnity risk. Each option has a differing impact on the lender’s reserve protecting its net worth in the event of a repurchase, and some risk management strategies implement combinations of both the above tools. Because it can be such a lucrative business, it is one part of mitigating the inevitable risk that lenders begrudgingly deal with as the non-QM market continues to expand.

Meanwhile, the Agencies motor on. For example, let’s take a quick look at a couple of Freddie’s K Certificate deals and you can see what investors are looking at, attribute-wise.

Earlier this year Freddie Mac priced a new $1.1 billion offering of Structured Pass-Through K Certificates (K-108 Certificates), which are backed by underlying collateral consisting of fixed-rate multifamily mortgages with predominantly 10-year terms. Pricing for the deal is as follows. Class A-1 has principal of $60.800 million, a weighted average life of 6.84 years, a coupon of 1.159 percent, a yield of 1.07401 percent, and a $100.4981 price. Class A-2 has principal of $969.091 million, a weighted average life of 9.71 years, a coupon of 1.517 percent, a yield of 1.18262 percent, and a $102.9933 price. Class A-M has principal of $142.601 million, a weighted average life of 9.88 years, a coupon of 1.526 percent, a yield of 1.19681 percent, and a $102.9935 price.

Freddie Mac also priced a $988 million offering of Structured Pass-Through K-Certificates (K-109), which are backed by underlying collateral consisting of fixed-rate multifamily mortgages with predominantly 10-year terms. Pricing for the deal is as follows. Class A-1 has principal of $92.980 million, a weighted average life of 6.56 years, a coupon of 1.036 percent, a yield of 1.02738 percent, and a $99.9993 price. Class A-2 has principal of $766.185 million, a weighted average life of 9.80 years, a coupon of 1.558 percent, a yield of 1.2256 percent, and a $102.9925 price. Finally, Class A-M has principal of $129.610 million, a weighted average life of 9.91 years, a coupon of 1.286 percent, a yield of 1.28092 percent, and a $99.9932 price. K-Deals are part of the company’s business strategy to transfer a portion of the risk of losses away from taxpayers and to private investors.

And Freddie Mac priced an offering of Structured Pass-Through K Certificates (K-738 Certificates), which are backed by underlying collateral consisting of fixed-rate multifamily mortgages with predominantly 7-year terms. The company expects to issue approximately $882 million in K-738 Certificates. The deal is priced as follows. Class A-1 has principal of $75.54 million, a weighted average life of 4.53 years, a coupon of 1.054 percent, a yield of 0.9281 percent, and a $100.4959 price. Class A-2 has principal of $693.48 million, a weighted average life of 6.54 years, a coupon of 1.545 percent, a yield of 1.0569 percent, and a $102.9943 price. Class A-M has principal of $113.27 million, a weighted average life of 6.79 years, a coupon of 1.645 percent, a yield of 1.1716 percent, and a $102.9988 price.

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T’was a few days before Christmas,
And all through the town,
People wore masks,
That covered their frown.
The frown had begun
Way back in the Spring,
When a global pandemic
Changed everything.
They called it corona,
But unlike the beer,
It didn’t bring good times,
It didn’t bring cheer.
Contagious and deadly,
This virus spread fast,
Like a wildfire that starts
When fueled by gas.
Airplanes were grounded,
Travel was banned.
Borders were closed
Across air, sea and land.
As the world entered lockdown
To flatten the curve,
The economy halted,
And folks lost their verve.
From March to July
We rode the first wave,
People stayed home,
They tried to behave.
When summer emerged
The lockdown was lifted.
But away from caution,
Many folks drifted.
Now it’s November
And cases are spiking,
Wave two has arrived,
Much to our disliking.
Frontline workers,
Doctors and nurses,
Try to save people,
From riding in hearses.
It’s true that this year
Has had sadness a plenty,
We’ll never forget
The year 2020.
And here we are –
The holiday season,
But why be merry?
Is there even one reason?
To decorate the house
And put up the tree,
When no one will see it,
No one but me.
But outside my window
The snow gently falls,
And I think to myself,
Let’s deck the halls!
So, I gather the ribbon,
The garland and bows,
As I play those old carols,
My happiness grows.
Christmas is not cancelled
And neither is hope.
If we lean on each other,
I know we can cope

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Rob Chrisman