Before Selling To Fannie And Freddie: Be Alert

Gain the expertise and experience to analyze basic decisions

Insider

Contributing Writer

As we’ve moved through 2023, lenders everywhere are reporting increased buyback requests from Fannie and Freddie, who have become more aggressive. The general feeling is that lenders, who have been consistently losing money or breaking even this year, believe the government-sponsored enterprises (GSEs) are not being consistent with commitments made in recent years about materiality and options for remediation and have changed their quality control and sampling methodology. Lenders, which obviously include independent mortgage banks, are using staff time and resources, thus adding costs to a lender’s bottom line.

Freddie and Fannie’s more aggressive posture may be because they are concerned about the potential failures of some of their lender customers during these difficult times, and therefore, they would lose their counterparty to warranty defects on loans should they go to default. But for the last several years, Fannie & Freddie’s end-run around the large aggregators and marketing directly to the small and mid-sized lenders is well known in the industry.

Smaller lenders may not have the expertise or experience (yet) to analyze some basic decisions between selling loans directly to the GSEs (through the cash window) or securitizing loans themselves. It is helpful to have a primer on what that means and know what might be going on behind the scenes influencing decisions.

A Primer

In selling directly to the GSEs, lenders have the option to sell for “cash” or to “swap.” If you work in secondary marketing, you no doubt have been asked, at some point, whether it is more profitable to trade agency products for securities or for cash. Approved lenders have the business luxury of either swapping closed loans they originate for mortgage-backed securities or selling these loans directly to FNMA/FHLMC in exchange for cash (known as “cash window” sales). There are some common misconceptions about cash window transactions and the collateral and prepay differences, if any, between pools securitized through the cash window and the MBS swap programs. It’s important to understand who uses the cash window option, why, and whether or not there are differences in pool characteristics.

When originators sell loans via the cash window, the GSEs aggregate the loans from a large pool of lenders and securitize them as an MBS; the cash window option allows both Fannie and Freddie to make short-term use of their balance sheet without interfering with their current mandate of continued reduction in their retained mortgage investment portfolio.

Secondary marketing departments choose to sell in this fashion for speed and efficiency. The agency cash window typically alleviates warehouse line concerns, a problem that plagues many small originators, by way of faster fundings. Borrower retention is maintained as well.

It’s important to understand who uses the cash window option, why, and whether or not there are differences in pool characteristics.

Model Contributors

In the fast and furious days of 2020 and 2021, getting loans out the door and paying off a warehouse line was of paramount importance. Quality and QC checks may have taken a backseat to volume and keeping up with locks. Typically, smaller lenders selling their loans to larger lender aggregators sell servicing rights as well. The cash window allows smaller lenders to retain their customer base while allowing them to continue to originate new loans. Historically, smaller lenders had two options: sell their loans to FNMA/FHLMC or sell to a large aggregator. As large aggregators have been closing the correspondent channel, small originators have become central contributors in the cash window securitization model.

Unfortunately, selling loans directly to Freddie or Fannie is a “two-edged sword.” The original price is probably better than selling to an aggregator (middleman), and the speed at which the purchase happens is often faster. In addition, a lender can retain the servicing. But lenders may want the cash from the servicing value (mortgage servicing rights), and dealing directly with Freddie and Fannie eliminates a buffer in terms of buybacks. They go back to the entity that sold them the loan, in this case, an aggregator, who may have more success in rebutting the repurchase request.

I expect smaller lenders to continue to sell to FNMA/FHLMC cash-window desks given that larger lenders like Wells Fargo have scaled back on their role as aggregators. Consequently, it is likely that the percentage of pools securitized through the cash window will continue to increase if not stay at current elevated levels. Given the comparable collateral characteristics and increased oversight by the GSEs on participating lenders, we can add caveat venditor (seller beware) to caveat emptor (buyer beware).