Originators should care what happens to the loans that they fund. They typically spend a month or two working with the borrowers, appraisers, underwriters, and an army of support staff in pushing a home loan “across the finish line.” But then what happens to it? And how has the secondary market changed over time? Every lender should know this information, because not only does investor appetite directly impact borrower rates, but the monthly servicing of that loan may result in questions for the originator.
Generally, loans are put into a security (mortgage-backed security, or MBS) or are put into the asset portfolio of an institution. But the details are more interesting, and complex. Why do certain investors hold certain mortgages?
There are a wide variety of entities out there that have a wide variety of securities in which to invest. Bonds backed by the Japanese government, revenues from a hospital in Mexico City, a sewer district in France — they run the gamut. Investors will look at this whole spectrum of fixed income securities. The government of Nepal might issue a security, or Taiwan, or Canada, or Fannie Mae or Freddie Mac. There exists a huge variety of fixed income instruments from which investors can choose.
How investors look at the world of mortgage-backed securities is in a period of transition. For example, the public pension space in the United States, represents about $5 trillion in assets. So, the Ohio State Troopers Retirement Plan, and Florida Teachers Pension Plan, carry a lot of financial weight. The percentage of who buys these securities has changed over time. So, if you went back three years ago to 2021, the Federal Reserve was the majority buyer at almost 60%of issuance. We had U.S. banks making up almost 40%, and then the remainder of MBS was purchased by foreign buyers. Foreign buyers were mostly buying FHA and VA loans placed into Ginnie Mae securities.
Flash forward to 2024, and it’s a completely different makeup. The industry is seeing new REITs (Real Estate Investment Trusts) accounting for buying maybe 5%of new issuance. Banks account for 20% versus 40% from a few years ago. So, banks have retrenched. It is a good argument that banks have done this due to the capital requirements that banks must hold onto their balance sheets. Foreign buyer activity has increased dramatically due to fluctuations in the value of the dollar but also because foreign institutions find MBS from the United States a very attractive investment, and with the supply down, their influence in price activity is more dramatic. Insurance companies and pension funds have traditionally purchased pools made up of 30-year loans to match the duration of their expected liabilities.
Now we have a new “player,” which is not necessarily new, but compared to a few years ago has had a large increase in its appetite of MBS. It’s the money managers. And large investors will “invest” in external money managers that are charged with handling their funds. These money managers often have billions of dollars to invest as the public asks them to invest money, or loans in existing pools pay off (refinance). It’s very easy for an individual to put money into a Treasury security and earn 5%. It is very difficult for a large institutional allocator to do so, as they usually have prescribed limits for what they can invest in, and to change those, they usually have to go through some sort of governance process.
So, why should originators care? The REITs tend to buy specified pools filled with loans of certain characteristics, such as loan-to-value, geographic area, or loan size. The money managers might be more interested in “TBAs” where the exact pool make up is not known yet. These underlying purchasers, and how much the nature of who the purchasers are, changed from the institutional perspective, going back to the global financial crisis.
After the financial crisis, institutional investors retrenched somewhat from the mortgage market and reallocated their portfolio into what they thought were less risky assets. But during the COVID pandemic this proved not to be the case. Instead, they started seeing effects of other parts of their fixed income portfolio, in addition to their equity book, start to have problems. Now, three years later, we’re seeing a rebuilding of those fixed income books so mortgages can fit into a couple places in institutional portfolios, they can fit into “fixed income credit” or even the “hedge fund book,” all in different flavors.
Other investors are “rebuilding their book” and often MBS are an increasing part of their asset allocation as they diversify their holdings and try to decrease their risk. Agency MBS (Feddie Mac/Fannie Mae) and mortgages in general imperfect correlations to other asset classes such as high yielding bonds and to treasuries based on different sources of risk. MBS have prepayment risk (from borrowers refinancing and paying off the security early), liquidity risk, and credit risk (unlike Treasury securities that have no credit risk currently). Money managers can choose mortgage pools in an attempt to minimize the various risk classes as well as maturities. They can choose Agency or non-Agency securities, such as pools made up of jumbo or non-QM loans.
Some investors are entirely focused on buying mortgage-backed securities from the United States. For them, the supply is very important, and many estimates have the 2024 total coming in around $1.7 trillion, much of it from loans used to purchase homes. The percentage of outstanding mortgages that can benefit from a rate and term refinance are very low; most refis are “cash out” with the money being used to remodel the home or pay off higher interest rate debt.
One of the biggest concerns for institutional investors is where interest rates are headed. No investor wants to be hurt if there’s further upside there, and if rates go up bond prices go down. And few, if any, large investors base their portfolios on an interest rate prediction, especially when a war, or sudden change in the political climate, or an unexpected disease can move the bond market dramatically.
At the “end of the day,” if there is no secondary market demand for a product that a lender funds, there is little to no reason for a lender to continue to offer that loan program. Capital markets staffs understand this and are always involved in deciding whether to roll out a new product or not. If a lender can’t offload the mortgages, it impacts that lender’s ability to continue to lend out and transact.
Would you like to speak to STRATMOR about our services? Contact us today!
Let us light up your strategy discussions.
Feel free to reach out with any questions or needs we might be able to help with.
