By the Numbers
The cash window is flush with slow servicers
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. This material does not constitute research.
Many non-bank servicers with loans that paid relatively slowly during the recent refinancing wave have been selling to Fannie Mae and Freddie Mac’s cash windows. These non-banks found the cash window provided good pricing and liquidity without the need to market their own MBS pools. But both GSEs will likely shrink their cash windows as soon as July, forcing these servicers to find a new outlet for their loans. Investors may find an opportunity to boost returns buying non-bank pools that offer bank-like prepayments at an attractive pay-up.
Many of the slowest lenders over the last three months were not banks (Exhibit 1). Of the 25 largest lenders with speeds below average, NewRez was the best performer with their loans coming in 33.5% slower than a reference cohort of comparable loans serviced by an average servicer. American Pacific Mortgage and PrimeLending, also non-banks, also prepaid slowly. And seven of the eight lenders that prepaid at least 10% slower than average were non-banks.
Exhibit 1: Slowest prepaying servicers from February – April 2021
% slower than reference measures how much slower a given servicer’s loans are compared to a comparable portfolio of loans serviced by the average servicer. Balance is total issued from May 2020 through April 2021 in Fannie Mae and Freddie Mac pools. Pay-up is calculated assuming the stated speed differential lasts for 36 months. A servicer is considered over the cash window limit if their combined cash window issuance to both Fannie Mae and Freddie Mac exceeded $3 billion. The 25 lenders were selected based on 30-year volume issued last year.
Source: Amherst Pierpont Securities.
Almost every one of the non-bank lenders shown is currently over the forthcoming caps on cash window use. Starting as soon as July 1, some lenders will not be able to sell more than $1.5 billion to each GSE’s cash window in a 12-month period. The cap will likely apply to all lenders by January 1, 2022. At the same time many of these originators, like American Pacific Mortgage, have been selling all their loans to the cash window or into multi-lender major pools and have not been issuing their own MBS. They will need to sell any loans that command a pay-up to a correspondent lender or start issuing their own MBS.
Investors may be able to enhance returns by buying pools backed by these servicers. Assuming constant OAS, the Amherst Pierpont prepayment model can estimate representative price premiums to TBA 2.5%s. The model’s refinance response is adjusted slower for 36 months and then returns to normal. The slowest servicers pools could be worth at least 7/32s more than a comparable pool backed by an average servicer. And the theoretical pay-up would be higher if the TBA is backed by an adversely selected group of servicers. However, investors may be able to buy these pools at less than the full pay-up.
Investors can buy these lenders’ specified pools, which should have better convexity than an average specified pool. Previously these loans were grouped into multi-lender cash window specified pools that also included faster servicers. Lenders might also be able to sell pools of generic loans that would otherwise be destined for TBA pools for a small pay-up. However, the special dollar rolls in 2.0%s and 2.5%s make it very challenging to create pools at low pay-ups, but this could interest investors that cannot roll.
Some caveats here. Past servicer prepayment behavior is likely a good guide to future behavior for pools coming from the servicer directly, while pools coming from a correspondent could change. And the limits on cash window use could change this summer if the Supreme Court gives the White House the ability to replace current Federal Housing Finance Agency Director Mark Calabria, who, with former Treasury Secretary Steven Mnuchin, put the policy in place.
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