Fannie Mae, Freddie Mac add a new fee for refinancing
admin | August 14, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Fannie Mae and Freddie Mac surprised the market on August 12 by announcing a new loan-level fee for almost all refinances, to compensate the GSEs for higher risks and costs in the current market. However, this fee is unlikely to raise mortgage rates since spreads between primary and secondary mortgage rates are currently very wide. This means originator profits are very high, and originators are likely to bear the added cost in order to maintain refinance volumes. MBS investors should not anticipate slower prepayment speeds due to this fee, and speeds may actually increase in the near term.
August prepayment speeds should be faster than anticipated since the fee encourages originators to close loans in August. The new fee is effective on September 1 for all whole loan sales to the GSEs, and for all loans delivered into pools with an issue date beginning September 1. Originators should attempt to close as many loans as possible in August in order to avoid the fee, pulling forward some prepayments that would have otherwise occurred in September.
News of the announcement might also pull in new borrowers that haven’t yet started the refinance process. These borrowers may call their lender in an attempt to refinance before the fee is assessed. While it is very unlikely a borrower could avoid the fee, since it would require less than 2 weeks from application to closing, they might find the originator is still able to offer an attractive rate.
The convexity of MBS pools may improve a little in the long run, since the fee should raise the primary/secondary spread floor by 12.5 bp to 25 bp. This means speeds will be slower than before in higher interest rate environments. And if interest rates remain unchanged then prepayment speeds will be slower in the longer term, since eventually primary/secondary spreads will contract and will reach the higher floor sooner.
Originators are extremely upset with the fee as they stand to lose a lot of money paying this fee to the GSEs. A major concern is that they were given almost no time to prepare. Loans already in the pipeline cannot be repriced to a higher rate and it is likely almost impossible for a lender to pass on the fee to the borrower. The GSEs could have made the fee effective with October or November delivery, or allowed loans with application or lock dates prior to the announcement to be exempt from the fee. This would have allowed originators to close loans already in the pipeline under the fee schedule in place when the borrower started the refinancing process and the lender communicated rates and costs. Lenders would then have time to incorporate the new fees into pricing, although ultimately competitive pressures and wide spreads are likely to make originators, not borrowers, bear the brunt of the cost. Correspondent lenders are even more likely to feel the effect of the fee since they may face the full cost but only capture a portion of the origination profits.
Fannie Mae states that the fee is being assessed to account for higher risk and costs borne by Fannie Mae in the current market environment, and Freddie Mac says something similar. One possible explanation is the increased use of property inspection waivers during the pandemic. The GSEs may be worried that they have extended appraisal waivers to too many borrowers, while the nature of the pandemic makes them reluctant to force more on-site appraisals, although exterior-only appraisals remained an option. Consequently the GSEs face more risk that their property valuation models are overvaluing properties that have defects that can only be detected through an on-site appraisal. For example, electrical or plumbing issues.
However, the average fee—roughly $1,400 in 2020—is substantially higher than the roughly $500 cost of the appraisal that was avoided. If waivers are the reason for the fee it suggests that the GSEs’ valuation models are miscalibrated. A rational policy would be to require an appraisal if the present value of incremental losses without the appraisal is greater than the cost of the appraisal. The would mean the GSEs are telling originators that they don’t need to do appraisals and in March expressly encouraged the acceptance of waiver offers, and now are passing on the increased cost of that policy to those same originators. Originators have the option to turn down a waiver offer and get an appraisal, including an exterior-only appraisal, and might have done so had they been presented an accurate valuation signal from the valuation models and been informed of the true cost of accepting a waiver offer. Borrowers that get appraisals may also question why their loan is being charged this fee.