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Taking A Peek At Secondary Market Options

A primer on selling loans directly to GSEs or securitizing loans yourself

Rob Chrisman
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Rob Chrisman
Secondary Market Options

As 2022 wound down, nearly every company involved in residential lending had been impacted by higher rates, lower volumes, and revenue, and a sense that 2020 and 2021 were indeed the best years the industry may ever see. In the secondary markets, the options have changed little this year, and the projections that Non-QM volumes would skyrocket have fallen short.

And thus, we have another year where Freddie Mac and Fannie Mae are the dominant players and expected to be for some years to come. And let’s face it: having that government stability is not such a bad thing compared to private-label security shifts.

But the timing of when the loan finds its way to Fannie and Freddie (the agencies) varies. Put another way, large and small banks, credit unions, and independent mortgage banks can sell conforming conventional loans to large aggregators/correspondent investors, or directly to the agencies. 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.

But smaller lenders may not have the expertise or experience (yet) in analyzing some basic decisions between selling loans directly to F&F (through the cash window) or securitizing loans themselves. It is helpful to have a primer on what that means and knowing what might be going on behind the scenes influencing your capital markets decisions.

Cash Or Swap?

To cash or to swap, that is the question. If you work in secondary marketing, you no doubt have been asked, at some point, whether it is more profitable to trade agency product for securities, or for cash. As many know, 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).

The share of Fannie and Freddie loans securitized through the cash window varies over time. 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. Why would a Secondary Marketing department choose to sell in this fashion? Simple: speed and efficiency. The agency cash window typically alleviates warehouse line concerns, a problem which plagues many small originators, by way of faster fundings. Also, borrower retention is maintained as well.

Comparative Advantages

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. And finally, an added benefit to the cash window lies in the small arbitrage (implied or otherwise) between “best efforts” and “mandatory.”

As noted above, a lot of the benefits of selling cash window are really comparative advantages for the smaller lender; maybe this is why I hear so often the phrase “we utilize the cash window” from capital market veterans. Historically, smaller lenders had two options: sell your 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.

For those of you wanting to dive a little more into the weeds, the GSEs’ co-issue portals have come a long way in the last three years: Fannie Mae’s servicing marketplace (SMP, which replaced SET) and Freddie Mac’s Xchange. What used to be a rather painful experience bifurcating mortgage servicing rights (MSRs) has changed. In the past, on the day of the trade, you had two transactions, one with Fannie, one with the servicing buyer, both required separate tapes to be created. A lender was paid by Fannie in typical fashion (within 24 hours of the notes being received), but you’d normally have to wait for later in the month to settle with the MSR buyer (an additional settlement tape needed to be created).

Early Payoffs Matter

In addition, the MSR buyers would hold back 10% of the trade until trailing docs caught up to the loans. All that’s fine on paper, but now the lender’s cash flows are a slave to the speed of county recorders and title companies. If the secondary department doesn’t have operational control over final docs/trailing docs, it becomes exponentially harder to clean up trades.

For example, in 1Q20 when COVID hit secondary departments were selling loans in January but not really realizing the full value of the cash flows until March. Using SMP/Xchange, the lender is paid on the full trade amount at the same time. Additionally, IMBs who don’t want to sell their borrowers to an aggregator, but retaining places a strain on cash/capital, have the ability to sell to a loan servicer who wants that loan to stay on their books.

Although rates have gone up, and rate and term refis have nearly vanished in late 2022, early payoffs still matter. Between the two channels, there isn’t much of a difference in prepayments. In addition, it is possible that additional measures taken by the GSEs ensure that prepays are comparable as well. Fannie Mae specifically monitors prepayments of pools created from the cash window and compares the performance to similar pools created through the MBS swap program. To the extent that prepays on cash window pools are significantly faster than similar pools created through the MBS swap program, a conversation with the lender may occur to understand possible reasons for the differences. As an added incentive, if necessary, Fannie Mae may limit or discontinue a lender’s activity through the cash window.

Small vs. Large

Seasoned capital markets staffs are typically fans of MBS swaps. The transaction has more moving parts than anything, and both capital markets and accounting need to be on the same page. A lender can realize full specified pool pay-ups and really are masters of their own fate. To have the ability to hedge with the same instruments you’re delivering into, and pricing off of, is ideal for any good secondary group.

I expect smaller lenders to continue to sell to FNMA/FHLMC cash-window desks if larger lenders scale back on their role as aggregators. Consequently, it is likely that the percentage of pools securitized through the cash window continue to increase if not stay at current elevated levels. Given the comparable collateral characteristics and increased oversight by the GSEs on participating lenders, prepays on pools securitized through the cash window are likely to be comparable to pools securitized through the MBS swap program.

This article was originally published in the Mortgage Banker Magazine January 2023 issue.
Rob Chrisman
Rob Chrisman

Rob Chrisman began his career in mortgage banking – primarily capital markets – 35 years ago. He is on the board of directors of Inheritance Funding Corporation, of Doorway Home Loans, of AXIS Appraisal Management, and of the California MBA. He is also a member of the Secure Settlements Advisory Board, an associate of the STRATMOR Group, and of the Mortgage Bankers Association of the Carolinas and its membership committee.

Published on
Dec 21, 2022
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