We are seeing from our clients that current market roll costs and the ultimate effects on execution are the biggest concerns for secondary marketing heads. Increased roll costs mean there is an increased time value of money, and it is essential to maximize efficiency on commitment periods, especially during certain times of the month. A surfeit of investors allows for them to accommodate and price to a specific number of days when submitting a bid tape as part of the chase for granularity. At the end of the day, shortening that commitment period is the best way for sellers to pick up anywhere from a couple to over a dozen basis points on loan sales.
Pricing deterioration is a direct result of roll costs going up. More volatility over the past several weeks has helped bid ask spreads to expand out, as does illiquidity on higher coupons. A potential need exists to assign trades unless you want more hedge cost based off of those spreads. This should be taken into account when hedging, because this cost will be incurred and needs to be charged to the borrower on the front end. Rolls will eventually contract with more production and liquidity in higher coupons. There is still a lot of inefficiency in those emerging coupons (5, 5.5).
With a lot of 4.5s being traded right now, emerging coupons are still illiquid, but agencies are looking to move up note rate tranches. Fortunately, there is more and more liquidity and production flowing into that way, and we are seeing traction in more liquid higher coupons like 4.5 rolls. Back in March, there wasn’t much of any liquidity in 4.5 and 5 coupons, especially on the Fannie side. On the GNMA side, a 5.25% note rate is as high as you can go to get you in the 4.5 coupon, so there is a lot of cross hedging taking place. For the agencies, keep in mind that there is the maximum 112.5 bps strip deliverability in a 5.5 coupon when you get to a 6.125% note rate or higher. Even with the move up in the market, a lot of the lower coupons trading below par are still being traded as primary coupons (25% or so of production trading in a 3.5 coupon).
On the back end, when the loan is executed, we have seen quite a few situations where longer commitments are causing clients to leave profitability on the table. Over the last two years, record volumes stretched post-closing and shipping departments thin, and longer commitments (seven days, ten days, or even further) were taken out. Definitely take dynamics into account when doing best execution analysis and make sure to add that spread back in for whatever production you are looking to sell. Investors have different ways of paying up, or not. Regardless, you are going to be better off with a shorter commitment period. You could be missing out on execution if you can deliver within two to four days but took out a 7-day delivery.
What used to be around half a basis point a day in roll costs is now a basis point or more, especially on rates being originated, and in some cases up to 2 bps. That means shortening the delivery window by three days could be a 5-6 bps improvement on the investor bid price. We have seen some clients submitting for 15-day delivery when they could do five or seven days. There is serious pickup that can be achieved with a shorter delivery period. How many days do you need to deliver the file? Closing, funding, and shipping quickly can save you on hedge cost.
Making the loan process more efficient is going to save you bps. Investors are pricing appropriately for elevated roll costs, and those higher roll costs amplify the pick up you can get with a more efficient process and delivery period. All that equates to better execution. Reach out to your trader for any front end pricing questions, lock extension questions, execution on the back end questions, or to have a discussion about the best options for your loan sales.
