The current market environment has been particularly tough on Independent mortgage banks (IMBs). The Federal Reserve has been buying government-sponsored mortgage-backed securities driving pricing up on TBAs. In the past, this would have encouraged a strong market for originators; however, this time around, it is creating winners and losers. IMBs don't have ready access to cash like banks, who can fund their balance sheet with the favorable conditions the Fed and the Cares Act has created.
Margins and production are at historical highs for banks and/or aggregators. However, IMBs are struggling for liquidity, especially if they don't have direct access to Fannie and/or Freddie loan sales or the capability of securitizing govies with GNMA. Most IMB business models rely on cash to originate mortgages and pay off their warehouse line. In the best of times, they don't have a lot of idle cash, but today, they are being challenged daily to manage all the demands on their cash and liquidity.
Liquidity and cash demands on IMBs:
The large rally in TBAs due to federal reserve purchases continues to cause significant margin calls for originators with their broker-dealers. The IMBs send cash to the broker-dealers to cover the calls and need to pay their pair-offs before the funds are returned.
Loan purchase prices declined or went away as investors expanded margins due to uncertainty in the market. This caused IMBs to receive less money on loan sales if the loan can be sold at all.
Aggregators and warehouse lines tightened credit parameters on their programs as concerns over forbearance and other issues caused by the Covid-19 crisis. This caused some unsaleable loans that are closed by the IMBs and ready to sell to the aggregators to go scratch and dent.
TBA counterparties start reducing or canceling their credit lines with IMBs due to credit concerns. This makes it harder and more expensive to hedge the pipeline.
An increase in haircuts on warehouse lines required IMBs to finance more of their originations with cash.
IMBs react:
1. IMBs had to reduce their credit parameters in order to originate loans that can be financed on warehouse lines and subsequently sold to aggregators.
2. IMBs widened their margins not to make more money but to ensure that they make enough to pay their overhead and loan officers.
3. IMBs are not fully hedging their pipeline as the loan sales are not moving with the TBA market and the lack of counterparties for TBAs.
4. For IMBs without direct access to the GSEs, they find themselves in non-competitive pricing for originating loans.
As FHFA and the Fed work to resolve the whipsawing of the market and stabilize servicer liquidity, it's shocking to see the same government who passed the Cares Act and codified the intent that forbearance isn't a credit event are charging massive fees for those loans. Originally, Fannie and Freddie were not going to buy “first payment forbearance” loans, or loans where the borrower had requested a forbearance before their first payment is due. FHFA issued some guidance (and ostensibly relief) for bankers juggling these abandoned loans. However, the “relief” is a 5 to 7 point hit on purchases and limited cash-out refinances only. In addition, the loan can only have a 30-day forbearance when the loans are sold to the GSEs. All of those cash-out refinances? Scratch and dent aren't going to help their liquidity.
In my opinion, this approach offers a number of unintended consequences. While the intent was to create a more stable capital markets landscape with the addendum, the LLPAs for these loans will be included in the pricing for mortgage origination participants. In addition, aggregators will be concerned with the turn times for purchasing loans from mortgage banks and being able to sell to the GSEs prior to the 30-day maximum. This creates additional pressure on the capital markets and does not resolve the issue. Healthy IMBs are important to support competition and serve local communities. Hopefully, when the aggregators and extension of credit facilities get comfortable with the issues regarding forbearances, the IMB will have a better environment to compete.
Karin Good, CFA
KMG Consulting
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