Secondary Marketing 101: Factors Impacting Mortgage Pricing

Secondary Marketing 101: Factors Impacting Mortgage Pricing

Dynamic between primary and secondary spread is playing out

BY JASON LEE | SPECIAL TO NATIONAL MORTGAGE PROFESSIONAL

In my role as executive vice president and director of capital markets at Flagstar Bank, I’m responsible for all secondary marketing, including marketing of residential mortgage-backed securities, pricing, margin management, and loan delivery. I’ve been in the industry for 23 years, starting out in secondary marketing in the Detroit area right out of college and then working with several major lenders across the country— always in secondary marketing. I’ve learned a lot along the way that’s helped prepare me for the curve balls that come with the territory.

With the uncertainty brought on by COVID-19, followed by the Federal Reserve’s jolt to the market for mortgagebacked securities, then the CARES Act and the confusion about forbearance, followed by the GSE pricing hits, I welcome the opportunity to provide some insight into the various factors that have affected Flagstar’s way of pricing in this topsy-turvy environment we’re operating in.

FORBEARANCE

First, forbearance is expensive. Right out of the box, Fannie and Freddie bumped up the pricing on loans in forbearance. We’re talking 500 to 700 basis points a loan. That created a lot of heartburn and uncertainty about future cash flow.

So, lenders tightened credit because of nervousness around defaults and possible foreclosure issues down the line. Many lenders dropped products and increased minimum FICO scores and down-payment minimums for certain loans in order to forestall defaults. Forbearance comes pre-packaged with costs for things like loan counseling, loan modifications, servicing, and foreclosure, if it comes to that.

As a lender, Flagstar looks for the sweet spot where we can continue to help our partners and our loan advisors and still make sure we’re protecting the bank. Here’s where our longevity in the industry, our liquidity as a bank, and our long history of focusing on relationships come into play.

SERVICING VALUATION

The value of servicing, which is the fee that an institution gets paid to administer a loan, also affects pricing. When a consumer makes a payment, the servicer processes the payment, applies it to the loan, tracks the loan and, if the loan is escrowed, pays the taxes and insurance. There is a fee built into a mortgage payment for this service.

The value of that fee is basically a forward cash flow, which investors purchase. A wild card here is the number of years servicing is expected to be in effect. Investors put a value on the cash flow of X amount of years of that money coming in.

So, they might figure, let’s say, the average 30-year mortgage is really around for six years. When there’s fear, uncertainty, or if rates drop, and there’s a high propensity for prepays or customers are incented to refinance to a lower rate, that cash flow could be disrupted.

Investors get nervous because of the high level of uncertainty around the pandemic. The value of that servicing asset goes to a very low multiple or sometimes zero. If you need to sell your servicing, you can find a buyer, but you might not like the price. As we get on the other side of COVID, the values will be back, maybe by the end of the year or Q1. Meanwhile, servicing valuation is another pricing pressure for lenders to contend with.

THE PRIMARY-SECONDARY SPREAD

The primary-secondary spread is the difference between the mortgage rate for borrowers and the yield on newly issued agency mortgage-backed securities. It’s the pass-through rate to sell a loan in the secondary market. When the spread widens—as it has recently—it’s often a capacity issue. The market works efficiently to limit demand to handle the influx of volume.

Flagstar is based in Detroit, so automotive analogies always work well for me. You can only push so many cars down the assembly line, and there are limited parts available and a limited number of people available to assemble the car, paint the car, etc.

In the mortgage industry, we’re looking at a virtual assembly line for home loans. We have only so much capacity to process loans. When rates dropped and demand skyrocketed, you didn’t see a parallel drop in the consumer rate because lenders needed to control capacity in order to serve their customers and deliver their product in a reasonable time.

As capacity is now becoming less of an issue, the primary-secondary spread is narrowing and the industry is getting back to business as usual— backfilling the roles needed to sustain our virtual assembly line. This means that rates are also falling for consumers. What we’re seeing firsthand is the dynamic between the primary and secondary spread play out.

PRICING AND THE RIGHT PARTNER

One of the maxims about mortgage pricing is that if it is too good to be true, then it probably isn’t true. The reality is there is no wizard behind the curtain, magically pulling pricing strings. It’s the net result of a handful of components, and lenders arrive at very similar numbers, though that’s not necessarily how they market them.

When push comes to shove, and a disaster—a pandemic or something unforeseen happens— you want a partner with stability, longevity, and transparency.

Jason Lee is executive vice president, head of secondary marketing & capital market operations, for Flagstar Bank.