Supply and demand is the most basic economic model for determining price in a market where demand is the amount of product or service that is desired and supply is the amount of product or service that is available. When either side falls out of balance, price is directly affected. This model has become more apparent than ever in today’s mortgage industry.
A simplified description of the players in the mortgage industry’s supply chain includes the originator, the aggregator and the agencies. The originator is self-explanatory. The aggregator, which sells paper to agencies and retains or sells the servicing rights, is the heart of the secondary market and has become dominated by large banks. The agencies buy the notes and guarantee the mortgage-backed securities (MBS).
Over the last four years, there has been a constant contraction of the secondary market (supply) in the entire mortgage supply chain. While the contraction has been across the board in all channels (retail, wholesale and correspondent), the industry’s third-party origination (TPO) channel has been most affected within the industry.
Since the “meltdown” first began, we have witnessed bank after bank exit the wholesale business and eventually vacate the mortgage business altogether. Since the decrease of supply channels began, we have seen an increase in administration fees, secondary market margins, and agency level g-fees. I believe this is only the beginning.
The first bank to send the shot heard ‘round the industry was Chase when, in 2009, they announced they would no longer accept business through their wholesale channel or correspondent division that was originated through a third-party. This created a huge vacuum in the wholesale market and many aggregators followed suit in the coming months. In September 2011, when Bank of America announced its decision to exit the correspondent channel, which supported TPO through correspondent lenders, it almost pushed the wholesale segment of mortgage lending into the abyss. The industry is just beginning to recover.
In recent months and as a result of the latest exodus wave, we have seen service-release premiums (SRPs) dwindle and margins increase. Historically, the pricing model for the secondary market uses agency (FNMA, FHLMC or GNMA) prices plus an SRP of 100 to 125 basis points (BPS). Today, we are seeing SRP values ranging from a negative factor to 25 BPS at the highest. This secondary margin and the government mandated g-fee increase at Fannie Mae and Freddie Mac is going to drive mortgage prices even higher. If other large secondary market lenders exit the space, then margins will continue to widen.
The void created by big banks vacating the secondary market is now being filled with smaller mid-level mortgage banks with direct agency approval. Direct agency approval, which only a fraction of the mid-level mortgage banks currently have, is crucial for a mortgage bank to be a continued viable entity. The likelihood and viability of moving forward in the industry will become grim without agency approval. With the increase in net worth requirements and the protracted turn times to get through the gauntlet of the agency approval process, those who have not started this process have a steep incline ahead of them.
The reality is that no one likes to see an increase in prices, but the fact is that if there is going to be a mortgage industry in the future, the participants have to be profitable. If a business model is not working, there must be a change that, in effect, creates revenue that exceeds expense. Those who can adopt this perspective will find the changes in the secondary market more palatable.
Mark Greco founded 360 Mortgage Group LLC, a privately-owned wholesale lender, and seized the opportunity to service the underserved wholesale segment of the market. As president of 360 Mortgage, he has overseen more than 50 percent growth every year. With more than 15 years of personal experience as a mortgage banker, Greco truly understands the business, and knows the issues facing the industry today. He may be reached by phone at (512) 418-6000.