Selling GSE-eligible mortgages is looking considerably more profitable than it has in years. Lender profitability has skyrocketed according to the Mortgage Bankers Association (MBA) performance data and our experience at ALM First Financial Advisors, helped by both a surge in lending volume and the Fed’s Federal Open Market Committee (FOMC) agency mortgage-backed securities (MBS) purchases.
The Fed’s quantitative easing actions associated with the Covid-19 pandemic have led to a major shift in interest rates. According to Freddie Mac’s Primary Mortgage Market Survey (PMMS), the going rate for a 30-year fixed is 2.67%. That is a record low for the entire history of the PMMS index, which has tracked mortgage rates since 1971. At the beginning of this year, this same rate was 3.72%, which has declined over 100 basis points in less than a year.
Despite the decline in interest rates overall, the price paid for mortgage loans have seen an almost equally drastic increase in price (an average two-point premium from the pre-pandemic levels). Figure 1 shows the Fannie Mae price for a 30-year fixed mortgage loan with a coupon equal to the prevailing primary rate at that time.
As Figure 1 shows, what started the year as a mortgage loan with a 3.72% coupon worth roughly 101.7 in price is now a 2.67% coupon mortgage worth about 103.7 in price. In other words, the price of a par mortgage has increased a full two points. Our experience at ALM First has seen lenders even topping 105 on net gain-on-sales, since pricing and going mortgage rates vary based on lender and product type.
The FOMC’s authority to purchase agency MBS plays a large role for the increase in gain-on-sale available in today’s mortgage market, since the loans sold to Fannie and Freddie represent the raw ingredients for the MBS securitization process. GSE-eligible loan pricing and Agency MBS pricing are joined at the hip, since the GSE’s are essentially passing the economics of the asset to lenders in the form of price, less servicing and guarantee fees.
Since gains on sale are quite a bit higher than historically, now represents a potential opportunity to be a liquidity provider in a time where the demand for agency mortgage-backs is high due to the Fed’s asset purchases. Taking advantage of this newfound market power represents a tactical opportunity.
To demonstrate, Figure 2 shows a hypothetical institution selling $10 million in mortgage loans per month. Using the current gain-on-sale estimate of 4% with a 0.15% monthly hedge cost estimate, this institution could generate $4.44 million in net annual gain-on-sale. This can be compared with the two-point lower premium in the pre-pandemic environment. In our experience at ALM First, many clients have experienced an over doubling of profitability in selling loans.
For a $1 billion institution, this increase in profitability is equivalent to 24 basis points in ROA. If this same institution can successfully improve processes to allow for more efficient loan origination, the profitability can be significant.
All this talk about profitability! Let’s not forget most depositories sell loans for the purposes of managing risk and liquidity. The sale proceeds can then be deployed into other earning assets, ranging from more lending to highly liquid assets. This can help institutions continue to provide valuable lending services while still managing risk and building capital organically.
Managing risk is of particular concern in today’s environment. During tough times, when interest rates tend to decline drastically, many forward-looking institutions put a focus on:
1) getting the balance sheet closer to a delta-neutral interest rate risk position
2) limiting low/negative-carrying assets (example: low-coupon long-duration mortgages)
These two objectives may help an institution, once the credit cycle turns, to have a protected margin should rates increase drastically and plenty of dry powder for a future increase in lending opportunities. Selling mortgage loans in today’s environment may assist in these objectives through the dual benefit interest rate risk management and profit generation.
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Alec Hollis joined ALM First Financial Advisors in 2012. As a Director for the ALM Strategy Group, Alec performs asset liability management strategy research for financial institutions. He also implements firm-wide ALM modeling procedures, and assists in the execution of client balance sheet hedging programs.
Alec holds a bachelor’s degree in finance from the University of Notre Dame, as well as the Chartered Financial Analyst (CFA) designation.
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