For several years now, the mortgage industry has grappled with a series of internal and systemic shocks that have created temporary disruptions and inefficiencies in the origination, financing, and sale of loans. And the future is no more certain: business volumes are expected to begin exhibiting year-over-year declines while regulatory uncertainty continues.
Throughout this period of upheaval and changing market dynamics, the most successful secondary marketing operations have thrived by embracing change and implementing flexible and dynamic hedging strategies, including:
Expanding mandatory servicing released investor relationships
Establishing agency servicing released and retained relationships
Building best execution into the hedging strategy
Performing best execution on a released vs retained and cash vs.mortgage-backed securities (MBS) basis
Incorporating mortgage servicing rights (MSR) value changes into hedging analytics
As they evolve and expand their business options, mortgage companies make common transitions: from broker to banker, best efforts to mandatory, servicing released to servicing retained, and servicing retained cash sales to MBS sales. However, from a best practices perspective, a comprehensive risk management strategy dictates that at every stage of development, credit unions should avoid all or nothing propositions in their secondary market execution. Typically, profits are maximized by actively comparing available execution opportunities and engaging in multiple execution paths simultaneously. Unfortunately, some institutions have legacy issues with one or more investors and are limited on either a temporary or permanent basis from reaching the highest level of execution flexibility. Others may have limits in either experience or capital that prohibit a servicing-retained strategy.
Whatever their execution options are, credit unions should be prepared to alter their secondary market execution for some loans during certain periods. By adhering to a robust best-execution discipline, these institutions can leverage all of the execution options available.
Secondary Market Execution Spreads And Price Volatility
Several key execution or pricing “spreads” are dynamic and credit unions should monitor these specific benchmarks continuously in order to optimize secondary marketing results:
Best-efforts vs. mandatory
Retained vs. released
Agency cash vs. MBS
Portfolio vs. sale
The spread between best-efforts and mandatory pricing is an important benchmark for those firms that have transitioned to mandatory execution, and it provides a gauge of the risk-reward for doing so. For a variety of reasons, this spread is in nearly continuous flux on an intra-investor, inter-investor, and inter-originator basis, so the only meaningful representation of this dynamic is on a daily, loan-level basis. Over the past several years, this spread has been very attractive for institutions that can effectively measure and manage their fallout and market value risk.
The market SRP (servicing released premium) that aggregators will pay also has great volatility. While SRPs are generally correlated to market interest rates, daily surveillance of investor pricing and MSR values indicates that SRPs are more volatile than the value of the underlying servicing rights.
From this information, the Mortgage Industry Advisory Corporation (MIAC) has concluded that market SRPs are driven by factors separate from the cash-flow value of the MSR, including a significant supply vs. demand component. For secondary market participants who are flexible enough to execute a hybrid strategy, this dynamic creates opportunities to retain servicing when the MSR is undervalued and release servicing when it is overvalued.
With respect to Fannie Mae and Freddie Mac, execution differences between Agency Cash Window and MBS are often overlooked. Fannie Mae and Freddie Mac have been driven by regulatory fiat into buy-sell mode. This means that cash execution is directly derived from pricing in the MBS market. However, as is seen with aggregator investor pricing, agency cash execution does not move in lock-step with the MBS market, and has its own hot-spots and cold-spots relative to MBS. As a result, secondary market participants who are executing on an agency-direct basis would benefit from a daily loan-level best execution analysis between these two execution styles.
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Tina Freeman, CFA, Managing Director, Secondary Solutions Group
Tina Freeman, CFA, is a 26-year mortgage banking professional with expertise in secondary marketing risk management, best execution optimization, servicing analytics, mortgage banking operations, and mortgage banking accounting.
Douglas Mayers SVP, Client Solutions Group
Douglas Mayers has a broad range of experience in the secondary market, including positions in sales and sales management for correspondent mortgage acquisitions, whole loan and distressed asset pricing and trading platform development, agency MBS pooling and delivery, and MBS acquisitions operations.
Since 1989, MIAC has been the leading provider of pricing, risk management and accounting solutions for the mortgage and financial services industries. Our expertise in secondary and capital markets, innovative price discovery methods, insightful collateral behavior analysis and widely validated software analytical solutions can enable and promote your company’s success in today’s challenging markets.