MBS MORNING: Explaining the Mortgage Supply Chain

by Adam Quinones

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Good Morning.

Short term day trader's MBS coupons of choice continue to lose their appeal to yield chasing accounts this morning. The richness of 6.00 and even 5.50 coupons is forcing "prepay anxious" levered (spending borrowed money) mortgage investors "down in coupon" into the production MBS side of the stack. This will eventually lead to MORE LIQUIDITY for the MBS coupons that mortgage originators wish to sell on the MBS market which just adds further stability and tighter ranges (depending on the gyrations of the yield curve).

There is a but...the relative value of mortgages remain at the mercy of the gyrations of the yield curve and its relation to the sentiment of the stock market. At 1030 this AM TSY yields went on the rise and MBS prices suffered, although not as much as TSY prices/yields...this implies that MBS yields continue to remain insulated from the broad extent to which mortgage's risk free benchmark yields go up or down. Translation:  although MBS is at the mercy of the steepness of the yield curve....mortgage buyers will continue to BUY ON WEAKNESS (wider spreads) and TAKE PROFITS ON STRENGTH (tighter spreads)....which has resulted in high liquidity and stable ranges. Furthermore "rich" MBS prices will exacerbate the selling on weakness..even though that willingness to let the stack cheapen has resulted in some reprice alerts(LIKE THE ONE WE JUST POSTED)....over the past month buyers have quickly returned to take advantage of cheaper MBS prices. Check out the choppy downswing of MBS prices as TSY yields shot up at 10:30...this shows MBS's resiliency while their benchmark deteriorates.

Trying to fight the sell off....look at the upticks in between the downticks...MBS FIGHTING!!!

WHILE TSY YIELDS GET PUNISHED BY SHORT TERM STOCK MARKET OPTIMISM...

Yesterday production MBS (rate sheet influential coupons)  prices moved slowly higher in a tight stable range, by afternoon a few mid level/regional lenders began to publish new rate sheets...but not everyone.

Why Didnt More Lenders "Reprice for the Better"?

Remember last week when we told you originators were dumping supply of MBS?  This "supply dumping" is how mortgage bankers lock in their income...much of the same way you lock in a rate and corresponding YSP of an individual loan.... except the investor's lock is a mandatory commitment (many of you do not utilize mandatory commitments because you do not wish to hedge your pipeline).  This process is most likely to occur when MBS prices are near the top of their trading range....much like you look to lock in your loans when YSP appears to have been "passed through".

By locking in last week lenders protected their pipeline from interest rate risk and locked in some profits in the process. This hedge is made possible by the "selling forward" mechanism within the in TBA MBS market. "Forward commitments" are however not always loans that are actually ready to be closed...they are loans that the investor expects to close by MBS settlement date.

Now that lenders have locked in their profits....they will  need to close loans in order to fill their "buckets" and meet their commitment....but they dont have to do it all at once. Lenders  who have already protected their pieplines will have the option to offer tighter pricing based on factors other than MBS day over day pricing fluctuations...like supply/demand of borrowers and the competitive actions of competitors.

How Does this Effect Smaller/Regional Lenders?

Smaller mortgage companies, like the lenders who compete on a regional scale, are often times slower to "pass through" intraday market gains. This is a function of the "trickling down" process of MBS gains through the mortgage pricing supply chain. Your position within the mortgage pricing supply chain is a factor of WHO you  sell your loans to and HOW you sell them.

Do you sell direct to FN/FRE cash windows? Are you utilizing mandatory commitments or best effort? How about Assignments of Trade? Maybe you are selling "bulk" pools of loans? Do you have a correspondent or broker relationship with your funding source?

There are several different conduits that a mortgage company can choose to sell their closed loans...all of which imply different market risks and back office responsibilities and correspond to different pricing haircuts and incentives. The farther down the mortgage supply chain you are...the more reliant you are on the investors above you to "pass along gains" . So many times you may find frustrations by our exuberance over MBS gains and a lack of cooperation from lenders who are looking  to balance their workloads and tweak their balance sheets..but those investors may be feeling the same frustration about their sources of funding.

The logical solution is to move yourself up the mortgage pricing supply chain, but we all know that not all lenders are fiscally or operationally capable of that....so in the mean time.... instead of focusing totally on the intraday movements of the loan securitization market...you will find a great deal of insightful guidance in the daily process of pacing the pricing behavior of your individual lenders and the relationship to the MBS market's improvements or deteriorations (something I am working on doing for you).