It’s an interesting time in the mortgage capital markets. The majority of the market is trading at a discount, both the MBS basis and payups have widened in recent weeks, and rate and term refinances are essentially non-existent. Fortunately, the TBA market is healthy and thriving: in terms of liquidity, it is firmly ensconced only behind the Treasury market. Investors, like Fannie and Freddie, are looking to create a bigger pie for originators rather than leaving lenders fighting over scraps. And compared to the last down-market cycle, data is better, technology is more robust, and the industry is smarter.
Last week, this weekly commentary talked about “roll costs” which have a few meanings in the MBS market. At a higher level, “dollar rolls” are tradeable positions that involve selling one delivery month of MBS to buy a future delivery month (or vice versa). Less formally, and in the way I meant it last week, the term is a simple time value of money concept used to refer to the settlement process in MBS. Investors are willing to pay more for a security that gets delivered to them more quickly. Since the price of a dollar roll is the same as the gap between this and next month’s MBS, it provides a quick way to refer to the drop in prices when we shift our point of view to a new delivery month. This week, let’s look at rolling from one month to the next.
Timing your loan delivery is going to have a large impact on overall execution, and there are only benefits to those that can manufacture a loan more efficiently. Right now, the liquid trade months are June, July, and August. We can trade for the next 80 days with notification day on August 9. That also means we can go 72 days days without incurring a bid offer spread roll cost. If we were to look back to trading last Monday (May 9th), our tradeable months were May, June, and July. That makes for only 64 tradeable days. The last day of the month can be a critical day to hit or you may have a quarter point loss.
The concept comes into play on longer locks (e.g., 75 days), but even more so on extensions. We are seeing in the market right now that a 30-day extension will cost more than twice as much as a 15-day extension, and a lot of investors are charging more on any second extension for a file. Alter your extension policy to limit exposure, and make sure you are aware of your extension costs. Stick to what your investor outlets are sticking to, which is normally two extensions. Look at the days you are allowing extensions as well. If you are in line with investors, it will limit your exposure, which also helps with note rate liquidity issues. Minimize your risk by staying within a certain window of time. Calculating the daily or weekly drop in price for current coupon Agency MBS is the hit that secondary marketing departments everywhere should be charging LOs for extensions.
Even with a delivery credit, you can often have better execution by delivering in an earlier month. We are seeing less consistency across clients’ investor sets. Some investors are not passing through the full roll cost of the bid, and some investors haven’t widened out payups for early delivery, which helps explain why certain investors are competitive at certain times of month and not at others. The moral is two-fold: pickup is amplified the more efficient you can get on delivery period, especially with elevated roll costs, and it is imperative to have enough outlets to manage if liquidity if a certain coupon goes away.
Our advice? Limit trades on higher coupons or assign those trades to investors. Investors are showing high rates but also increasing upfront fees for extended locks (90 to 180 days). Ask us about policies and explanations. There is no need to hedge until high note rates get closer to market rates. On loan sales, some people deliver a commitment the day after funding, but because of the current market, a lot of our clients are not selling everyday. While holding volume incurs an extra time value of money cost, these clients are picking up on the AOT. Look at what the spread is on coupons: using 1.5 bps as an approximation for hedge cost, if you can save 15 bps by doing an AOT, it makes sense to hold the loan three or four more days and incur that 1.5 bps/day cost but save 15 bps on assignment. There is a reward for efficiency, but an AOT can save a substantial amount right now.
From a cash window perspective, you can take out a cash forward to reduce the bid ask spread and get around AOTs with the agencies. If you need to get out of position by pairing out, Fannie/Freddie will likely give you the offered screen price in that scenario. When a TBA isn’t an option for forwards, adjust for the bid offer spread you are going to incur versus assigning the trade. This will range by coupon for what you need to add for your savings. Keep in mind that the GNMA side has wider bid ask spreads, sometimes above .125. We are seeing competitive bids on the dealer side through TAM, which helps you to not worry about rolling a 30-day trade a second time.
What else are we seeing in the market? I’ll give the last word to our COO, Phil Rasori. “We are seeing a coupon curve that is bound on the premium side. As we’ve transitioned to higher coupons, there isn’t liquidity or demand in those higher coupons. The Fed isn’t buying it, and that has increased the bid offer spread cost. Because there is no demand on the investor side for those coupons, there is no willingness to pay a substantial premium over par. The high end of rate sheets went from trading at 105 to now being lucky to trade at 103. Between corporate margin, loan originator compensation, and LLPA price adjusters, it is hard to deliver a no points loan to a borrower. Borrowers now must bring points to closing versus previously going up the rate sheet without being charged points.” That’s all for this week. Feel free to send any questions or comments to firstname.lastname@example.org.