Where the agency shift to securitization creates opportunity

A seismic shift is coming to the secondary market, and if you’re an agency-direct lender, there’s a good chance you’re already deliberating over it.

I’m referring to a market update from the U.S. Department of the Treasury and the Federal Housing Finance Agency that’s going to impact the government-sponsored enterprises’ cash window beginning Jan. 1, 2022. Under the new policy, the GSEs will cap cash window commitment volumes, limiting the amount lenders can commit to $1.5 billion apiece over a four-quarter period for Fannie Mae and Freddie Mac — a $3 billion total limit.

To put the impending impact in perspective, lenders of all sizes, including some of the largest in the nation, deliver to GSE cash windows as their primary business model. And to underscore things, many correspondent investors derive pricing from GSE cash windows rather than MBS securitization-based pricing models, while also favoring selling to the cash window themselves.

In short, if you’re an agency-direct lender who has historically exceeded, or expects to exceed, the $3 billion volume cap — even if you’re tempted to chalk it up to the record-low rates we saw in 2020 — you will likely be impacted by this disruption. And while it is indeed just that — a disruption — it doesn’t have to be synonymous with a burden. So often, industry changes like this one are cast in a problematic light and met with apprehension, or even fear. And while it’s wise to approach shifts of this magnitude cautiously, it’s also important to remember that changes usually bring opportunity; those who want to capitalize on it must be forward-looking and willing to put in the work.

In this instance, the opportunity at hand is pivoting to deliver some, or even all, loans via a securitization delivery model. The securitization process, simply put, occurs when lenders exchange a pool of loans for an MBS backed by those loans. While different from the cash window, securitization is a sound delivery model for any lender when combined with adequate research and preparation. It offers unique benefits, too — especially in terms of greater control and efficiencies.

Let’s start by looking at the most notable differences between the two delivery models. Perhaps the biggest one comes with funding and cash flow implications. One of the core value propositions for GSE cash window delivery is the reliably fast purchase times the agencies provide, which is the lifeblood of an independent mortgage bank. Thus, a chief concern for such a bank when considering securitization is cash management relevant to pooling cycles, which can leave loans on a warehouse line for a longer period.

However, lenders have many options to deal with the cash crunch. Fannie and Freddie offer compelling early-funding programs, and broker-dealer repurchase lines can be a savvy strategy, too. With proper planning, lenders can introduce the right approach to keep sufficient warehouse lines available to avoid impacting their funding needs.

Another point of comparison comes with pooling requirements. Achieving best execution at the cash window can be complicated enough, and the formation of MBS pools adds additional nuance. Single-issuer MBS pools require a minimum of $1 million in unpaid principal balance, along with additional loan composition restrictions, which can pose a challenge when it comes to delivering the loan to the pool you want to create vs. the one that can actually be formed. Pool optimization technologies can be helpful tools to simplify this process. It’s also worth noting that the resulting MBS pools that are formed typically lead to more specified pay-ups than those offered by the cash window, boosting a lender’s bottom line.

The theme here is that securitization comes with more assumptions to manage. And while that may sound intimidating, there are resources abound to help with the shift. Fannie Mae and Freddie Mac offer extensive support on the process, and commercial pipeline risk management systems can simplify the best execution math and delivery options. Many lenders will recall the intimidation that came with shifting from a best-efforts delivery model to a mandatory one, or the concern of the unknown that came with retaining servicing for the first time. Change always comes with growing pains, but in the case of securitization, you get a fair share of benefits in exchange — not to mention the excitement that comes with forming your own pools.

To start, securitization gives lenders the benefit of greater knowledge and control. This is the case to several ends — closer relationships with broker-dealer partners, more direct understanding of how lending profiles impact end pricing, and more transparency to the individual components of pricing.

From a risk management perspective, MBS securitizations can be a more elegant hedge proposition to take to your senior leadership team, too. This is the case because they offer a more predictable cash flow timing between pool sale and hedge settlement, plus increased visibility into impending model changes, such as buy-up/buy-down grids. This means more insight into projected daily and monthly profit and loss (P&L) changes, and better attribution of how various inputs impact the bottom line.

In terms of operational efficiencies and P&L considerations, there are additional benefits. Securitization offers a more predictable delivery schedule, which implements scheduled settlements that can be defined by the lender. As mentioned, the delivery model also brings the opportunity for increased specified pay-ups by forming single-issuer pools, plus reductions in explicit early payoff fees, bid-ask spreads and hedge costs. Moreover, lenders have much more control over and visibility into the inputs that drive their valuations, reducing the extent to which they rely on opaque rate sheets and investor-pricing models.

Benefits and differences aside, the most important thing to emphasize is that the shift to securitization should be taken seriously, but it shouldn’t be intimidating. After all, it’s nothing new; the industry operated this way for many years. Securitization is attainable with proper preparation, and it brings tremendous potential for forward-looking, ambitious lenders.

As an industry, this is an exciting moment. We can either embrace the opportunity and get to work or let trepidation get the best of us.