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.
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.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.