Why Are There So Many Loan Products? | Oct. 14, 2024

Jim Glennon: 00:00:03

Welcome to Optimal Insights, your weekly source for real time rate data and expert capital markets commentary brought to you by Optimal blue. Let's dive in and help you maximize your profitability this week.

Jim Glennon: 00:00:15

Welcome to Optimal Insights, your weekly source for timely market analysis and expert commentary from Optimal Blue. I'm your host, Jim Glennon, vice president of hedging and trading client services at Optimal Blue.

Our clients and industry partners have long relied on optimal blue for trusted insights and commentary, and these podcasts are an evolution of our commitment to keeping the industry informed. Let's dive into today's episode big welcome to our podcast crew.

As always, we have Jeff McCarty, director of product management, and we've got Kevin Foley, also director of product management. And from our desk in Denver, we have hedge account manager Alex Hebnere, one of our resident experts on all things econ and market.

All right, today we've got some really good information for you guys. We'll start, as always, with a market update. We'll get into that here in a sec with Jeff and Alex.

And then our segment after that is going to be the first part of a two parter where we're going to talk a little bit about product evolution. How have mortgage products ballooned over the past several years?

And why is the industry getting so granular and complicated in terms of loan products?

And today we'll start with some discussion about where all of our loans ultimately end up and why that's a driving factor of why there's so many, so many products out there. But to begin, Jeff, there's a lot going on out there.

Jeff McCarty: 00:01:33

Yeah, obviously, big news in the US is another hurricane going through Florida. I think, you know, coming out of that, over the coming weeks and months, we'll see how much damage it's caused.

You know, what effect that has on the mortgage industry, home insurance. You know, there's going to be a lot of money spent rebuilding. So, so what type of downstream effects does that have?

We'll be watching closely, obviously, just, you know, these devastating hurricanes back to back, putting a lot of pressure on a lot of different parts of the economy and the country.

Jim Glennon: 00:02:04

Yeah, brutal. Obviously. Our thoughts and prayers go out to everybody down there.

Jeff McCarty: 00:02:08

You know, beyond that, we've got, had some CPI and PPI numbers come out this weekend. Alex will be talking more about that and what effect that's had on mortgage rates.

We've seen obviously a rise up in rates from kind of hitting the lows, what about three weeks ago? At this point we've seen rates rise almost a half a point from the lows. So get into some more detail on that.

It's obviously not great news for our industry. We're also hopeful about rates, rates falling and now they bumped back up some.

Jim Glennon: 00:02:40

Yeah, I mean, we're still feeling the effects of the strong labor statistics we saw last week. And then you've got mixed bag with inflation data this week.

And although we've had this pause of rates, we should still be thinking about and expecting rates to go down in the medium to long term. So keep planning your recapture strategy. We talked a little bit last week about that.

We also talked about reviewing your originator comp to, you know, account for the fact that refis probably need to be done a little bit more competitively over the next, next couple of years.

Jeff McCarty: 00:03:12

Yeah, this is again just an early reminder and hopefully a long trend down in rates that it's not a linear move, it'll be peaks and valleys, but hopefully generally trending downward in the coming months and years. Right.

Jim Glennon: 00:03:29

So, yeah, stay tuned. We have a ton of playbooks on the sidelines that we'll bring in for different types of market conditions.

So OBMMI, just to riff on that real quick, 6.4.

So it is up quite a bit from, as Jeff mentioned from a few weeks ago when we were getting really close to seeing a five handle on that number, and that's obviously done a number on volume. Volume is not plummeted by any stretch, but we've come off of the highs quite a bit over the past few weeks.

Jeff McCarty: 00:03:58

Yeah. Even towards the end of the week, starting to see volume tick down.

We watch lock volume by day pretty closely, and even the past few days we've seen the volume decrease some. So having an immediate effect on volumes. This tick up in rates over the past week or two.

Jim Glennon: 00:04:17

Let's check in with Alex and see if we can get a little more information about what's going on in the market.

Jeff McCarty: 00:04:22

Yeah, Alex, thanks as always for joining us. Maybe you can talk us through some of the numbers that have come out over the past week that's been the cause for this recent run up in rates.

Alex: 00:04:32

Thanks for having me, Jeff. Yeah.

After last week's unemployment numbers, which showed a strong jobs market, this week we've seen some inflation metrics, which is the Fed's second mandate to keep a check on inflation, make sure our dollars continue to be worth what they're worth today or more or less. So CFI numbers on Thursday came in just a little bit above expectations. The expectation was 0.2% month over month.

It ended up at 0.3% and so on the year, we're sitting at about 2.4% inflationary rate. That's kind of in. I'd say that's on the high end of where the Fed has said they're comfortable.

I want to say, like two and a half percent is going to be, they're going to draw a hard line at two and a half percent on inflation. So at 2.4%, I don't think anyone's happy to see 2.4%. But the Fed is comfortable with it for the time being, and the market has responded adequately.

Jeff McCarty: 00:05:22

If it comes with strong employment numbers, I think theyre okay with that. They are pretty focused on those employment numbers, right?

Alex: 00:05:31

Yeah, I think the fear is stagflation.

And so a weak economy combined with inflation, what we have right now is a little higher inflation with a strong economy, and inflation is just a symptom of a strong economy.

Jeff McCarty: 00:05:47

Yeah, it makes sense. So anything specifically in the inflation numbers that are worth mentioning, Steven, we saw.

Alex: 00:05:55

Energy costs were down. Those really hit the inflation numbers.

On the downside, food, which is everyone's main complaint, generally speaking, on grocery bills, that was up a bit, but they netted out, kind of, like I said to, right around the expectation for the market for 0.20.3%.

Jim Glennon: 00:06:12

Right. And that's the CPI number that came out on Thursday. Right. So that's us. That's consumers going out and buying goods.

And what do those prices look like? And then Friday we had the PPI number, which is kind of wholesale goods. Right. Producers of goods, how much are they paying for everything.

And that number came in flat, correct?

Alex: 00:06:31

Yeah, yep, yep. PPI, that's the number that. Yeah, yeah.

The businesses, manufacturers, throughout the economy are seeing what they are receiving for their goods and services. Goods were I down 0.2% on the month, what the cost for that was, and then services were up 0.2%. So, yeah, it netted out to flat on the month.

And some people do see PPI because that is the production in the economy, the goods being made as somewhat of a leading indicator on CPI, and that PPI can filter down to the consumer. So keep an eye out in the next few months, see if CPI doesn't tick down as well.

Jim Glennon: 00:07:05

Great. Yeah, we'll hope so. What is the latest with geopolitical events?

I think, you know, it seems like there are, you know, red spots all over the world, beginning with issues going on economically in China, and obviously there's, you know, still a lot of geopolitical tension out there. That, that seems to be heating up. You know, I, I follow Jamie Dimon. So a little bit of an update on what he's thinking.

He still has some concerns that over the next couple of years, if any of these, if there's any spillover, some from some of these wars, that there's going to be spillover and it's going to have cause headwinds for the world economy.

Alex: 00:07:42

Definitely, definitely. There remains, I mean, a number of conflict zones around the world.

I think the ones that are most in our spotlight here in America, the war in Ukraine and the conflict in the Middle east, that the conflict in Ukraine seems to be fairly stagnant for the time being.

So I think a lot of people's concerns right now remain on the situation in the Middle east and making sure that that doesn't become more of a regional conflict. Right now, fairly confined to the Israel Palestine area, a little bit of Lebanon.

apparent late Covid era, like: 2021

They had a property company, property development company called Evergrande that declared bankruptcy. This really put the chinese housing market under a microscope. And so we've seen large declines in property valuations in China.

And that's like, same as it would be here in America if we saw massive property devaluations in our housing market. That hits the economy in general. Just your owners of property feel poor day to day.

If your home has lost 30, 40% of the value, you're not going to go out and spend as much money at the mall or the movie theater, wherever it may be.

Jeff McCarty: 00:08:53

The chinese government has tried to take some actions, but it doesnt look like the chinese markets are buying into what theyre trying to sell.

Alex: 00:09:03

Yeah. So a few weeks ago, chinese markets just came off a week long holiday for them over on their side of the world.

And in the lead up to that holiday, the market rallied something on the order of 30%. The Hong Seng index, thats the Hong Kong market. Thats how western buyers of chinese equities and debt tap chinese markets. It rallied up like 30%.

It'd been on a slow decline for four or five years. It's kind of ticking down, like I said, just on that property value weakness and weaknesses in their manufacturing industry as well.

We've seen some of their, some manufacturing or from, like, american western companies, they've found that chinese labor is getting a little more expensive, so they've taken their manufacturing to Southeast Asia mainly, you mainly see stuff coming from Laos, Cambodia, Vietnam now. But, yeah, no, we've continued to see some weakness in the chinese market.

So over that holiday that I mentioned, Beijing, the chinese government, they announced that there would be some help coming from the government.

And at the market opened, the market responded that this help that was coming, they're pulling $200 billion forward from next year's budget to invest this year and help prop up the market, prop up firms. And the market deemed that not sufficient enough. And we saw like a 10% sell off in one day.

So it's been very up and down over there in China and their equities market. And like I said, that's just a broader reflection of some weaknesses we've seen in their economy.

Jim Glennon: 00:10:28

Yeah. And you mentioned it's been about a five year slowdown of their economy.

And with the election coming up, it's worth noting that that is close to where the effects of some of the tariffs that have been imposed upon China started.

It's hard for me to find a lot of articles on this, but it does seem likely that the trade wars tariffs that were imposed upon China have led to some of this slowdown in their economy. It makes sense that the margins on chinese products were probably enormous prior to that.

And now that it costs a lot more to import chinese goods into America, the largest economy in the world, that theyre having to start lowering those margins and thats leading to wealth effects in their country, which then trickles down to housing and all the things you just talked about just being stressed.

Alex: 00:11:19

heir economy begin to emerge,: 2018

And yeah, that does line up with the declaration of the quote unquote trade war under Trumps administration. Like you said, you really dont see a lot about these tariffs, but all those tariffs are still in place, not more. So.

I know Biden has signed in additional tariffs into law. So at this point, from our side of the Pacific, tariffs are kind of a bipartisan issue. Both sides kind of support them.

Both parties are pretty hard on China or want to appear to be hard on China. And so, yeah, those tariffs remain in place.

Like you said, lower margins for chinese manufacturers and also the tariffs in China have led to western companies leaving China, taking their manufacturing elsewhere, mainly Southeast Asia like Vietnam. You've seen a lot more manufacturing coming out of Vietnam in recent years because.

Jeff McCarty: 00:12:09

Of that great update on, as you said, the second largest economy in the world.

So always something to keep an eye on and then great to touch on some of what's going on in the Middle east, which probably underrepresented in our conversations for how big that could potentially become. So we'll keep a close eye on that one going forward.

Alex: 00:12:34

Everything's tied together. We live in a global world, and it's always good to keep your finger on the pulse around the world.

Jeff McCarty: 00:12:39

Yeah. So what do we have coming up over the next week then?

Alex: 00:12:46

Biggest thing we've got retail sales. We are a consumption driven economy. 60 odd percent of our gdp is consumption. But housing specifically.

Next Friday is going to be the big day for us here in the mortgage industry. We have both building permits, building starts.

So just keeping an eye on housing supply, I'll tell you right out the gates, it's not going to be enough. Supply is probably a top two issue for us here in the mortgage industry.

Just home affordability is not going to be solved on the demand side because everyone wants a home and there's simply not enough of them. So regardless of where that one lands, I hope the number's high. It won't be high enough. That's all I'll say.

Jeff McCarty: 00:13:28

That's great. Point and quick plug for our sister podcast, the Market Advantage monthly podcast that Brent O'Connell and Olivia Delancey do.

They just had a conversation with Joel Kahn from the NBA this week.

Really good conversation on just those topics, you know, the effects of housing supply on the mortgage market, on volumes, and some conversations around first time homebuyers. Make sure check out that podcast as well. Great. Well, Alex, thank you so much for joining us this week. As always, great information.

Alex: 00:14:03

Thank you. Appreciate it.

Jim Glennon: 00:14:05

Thanks, Alex. And welcome back, Kevin and Jeff. We'd like to talk a little bit today about loan products.

And as promised, over the next couple of podcasts, we'd like to shed a little light on why the universe of products just seems to be ever expanding our own planetary universe and really get into some of the root causes of that and where the money for mortgages ultimately comes from. So, I mean, to start, it feels appropriate to talk about that last piece, where does capital come from to fund american mortgages?

And ultimately that it comes from the street, right?

It comes from the investor, whether that investor is the Fed during quantitative easing times, or it can be money market funds, it can be foreign wealth funds. But in any case, that dynamic is constantly seeking better and better yields and better and better returns and more predictability.

And that gets us to a conversation about what is a specified pool. So we'll talk a little bit more about that. But let's also get some context from the front end. Right. What are loan officers seeing?

What are originators seeing? What are borrowers seeing? Kevin, what are you seeing in rate sheets today?

Kevin Foley: 00:15:27

Yeah, well, I think it's a great point. So if we take this from an originator's perspectives, over the last ten years, we've just seen loan programs and pricing get a lot more complicated.

So if I was an originator ten years ago, what I would have seen on my rate sheet is typically one conforming 30 year fixed grid. But now we have grids for different loan buckets, loan amount buckets. So, you know, eighty five k, one hundred ten k.

We might even have some for non owner occupied, you know, conforming 30 or fixed non owner occupied grid, some for state specific like New York. And on top of that, we've seen adjustments getting a lot more granular as well.

And I know we'll touch on this a little bit more in our second segment, but we now have adjustments that are so granular as to what census tract the property's in, and different LLPA waivers for area median income, the income of the borrower relative to the income in the county. So things have gotten a lot more complicated. There's a lot more to keep up on.

And I think the goal of this segment is really to help understand what is driving these trends. And not to spoil the secret, but there are kind of two major trends. Right, guys?

And maybe you could help help me understand what are those major trends and which one do we want to dive into today?

Jeff McCarty: 00:17:00

Yeah. So there's two different dynamics here, right? There's sort of the policy driving some of those. So some of the area median income adjustments.

And then there's also just demand for mortgage backed securities, investors actually trying to generate yield, true investors of mortgage backed securities trying to generate yield. And that's the one we'll focus on today and talk about some of those dynamics.

Jim Glennon: 00:17:24

Right. So that totally makes sense.

On the front end, we are seeing whether it's the GSEs creating liquidity or the aggregators of the world, the Pennymacs and the Ameri homes in the world creating a market. They're trying to be more and more competitive and go along with this newfound granularity over the past few years.

Let's talk a little bit about exactly what's driving that and demystify a few terms you may be hearing. We've mentioned specified pools, and we've also mentioned the topic of duration.

What you have is the end investor who actually puts up cash to buy these bonds that ultimately securitize all the loans that we're doing in our industry, they're looking for, they're looking to pay for a stream of income, and they're looking to pay for an interest rate. They're also looking for that bond to pay for a number of years into the future.

So anything that they can get ahold of, any loan characteristic that they can see in a loan pool, that might mean that loan or that pool of loans is going to pay for a longer period of time, they're going to pay up for that, and that's ultimately going to end up in your rate sheet. So the examples that you mentioned, Kevin, low loan amount.

Obviously, a borrower who borrows a smaller amount of money relative to the average three $400,000 loan is likely not going to be as sensitive to interest rates when they move lower. So they're likely to what we call prepay slower or later in the process or later in the rate path.

Same with New York state, believe it or not, has its own spec pool and its own products. Because New York and Florida and a few other states, it can be very difficult to foreclose on homes. It can take up to a year or more.

So therefore, that loan, even if it goes delinquent, is going to pay for longer as the GSEs guarantee those payments.

Kevin Foley: 00:19:16

Well, I think that's a really important point, Jim. So what you're saying is investors.

So the folks who buy mortgages on the secondary market are really driving this change because they're looking for opportunities to earn more money on loans that don't prepay as quickly. And they've found these different niches, like low loan balance, state specific laws to help them earn more money.

How does a spec like this or a specified pool come into existence? What are the mechanics that actually make that happen?

And then how do we see that ultimately impacting what an originator might see on the rate sheet?

Jeff McCarty: 00:20:04

So this is where we do our schoolhouse rock episode of how a prepayment, how a specified pool is made, right? We can do a whole song and dance.

Kevin Foley: 00:20:16

I'm just a spec.

Jim Glennon: 00:20:19

Where do specs come from, Kevin? Yes. Well, they originate, again, at the ultimate buyer of these securities.

All of our loans that we produce ultimately end up either at a bank or either in a bank portfolio or in a security.

And the buyer of that security who puts up capital to buy that wants a stream of income that comes from the interest rate that comes from the borrower, and they want that stream of income to be ever more reliable going into the future. Right. And that's the word duration. When people say that as it relates to mortgages, they really are talking about time.

How much time can I expect that interest payment to continue coming in?

So any characteristic that I can find that will give me a reasonable expectation that that stream of income will continue for longer, I'm going to pay more for that today.

Kevin Foley: 00:21:12

So they end up talking to the broker dealers and say, hey, if you can get me a pool of low loan balance loans, I'll start paying up for that. And then that information just sort of gets filtered throughout the lenders who are selling, and voila, the spec comes into existence.

Jeff McCarty: 00:21:33

Yeah, it's exactly more or less very simplistically what happens, but it's all driven by underlying data, right?

So there are teams of people at all these banks independently in the industry that are pouring over historical data from the agencies to look at how these types of loans have historically, prepaid or not prepaid relative to the average. They look at all that and they say, this is what we expect to also happen going forward.

And because we expect that to happen going forward, we're going to estimate how much more these types of loans are worth than a normal loan.

And then because this market is so liquid, to your second part of the question, because this market is so liquid, it's pretty transparent what these pay ups are. There's kind of an average of what's being offered in the industry.

Everybody generally knows what these specified pool payups are for certain types of criteria.

And then, as you said, it just sort of gets filtered down through various channels, whether it's dealers sending out color, to say, this is what we're seeing on average, that then gets passed on to rate sheets, for instance.

Kevin Foley: 00:22:54

Yeah, and I think that's another important point to dig into a little bit because you kind of have this balance of, you know, the lender needs to understand what the specified payup is going to be. You know, maybe that changes, you know, over time.

And then they also need to make a decision around how to present that to the originator so that the borrower can take advantage of that.

But, you know, just thinking like an originator, you can think that there's going to be more friction that is introduced into the origination process. Uh, by, you know, just imagine trying to have a conversation with a borrower, hey, I'm looking for an $84,000 loan.

While the specified pay up limit is 85,000. Let's say 15 days in, the borrower comes back and says, oh, I'm going to need 86,000. Well, sorry, borrower we're going to need to adjust your rate.

That's, those are difficult conversations to have. And that's just sort of the, the world in which we live in now that originators need to navigate.

They need to be aware of these things so that they can better understand and prepare themselves and educate their borrowers on what their options might be.

Jim Glennon: 00:24:05

Yeah, I mean, that's the balance. Right? Like, how competitive do you want to be? How sharp do you want to make that price at $84,000?

But then how flexible do you want to be if you do have a client who wants to bring in a couple extra thousand dollars of cash out and bumps them into that worst price tier? Right.

And I think the message that goes along with that, too, is I, we're going to continue to see ever more granular products and ever more granular payups because there is just this overwhelming desire need to be more and more competitive.

Kevin Foley: 00:24:38

Yeah. And we've talked a lot about how this impacts conventional pricing, but we're seeing similar things to on the government side as well.

Maybe they're just not quite as obvious.

Jeff McCarty: 00:24:51

So you're going to see the same dynamics with loan amount buckets on the government side as well. Very similar dynamics there.

One of the interesting things that's really starting to show itself more over the past several months and years is a dichotomy between FHA and Va. So usually those FHA, Va, and USDA loans all get bucketed together in the same securities.

We're starting to see FHA specific pools be created, and the reason is that we are starting to see payups on FHA loans in particular. And so one of the big reasons for that is the differences just between FHA and VA and the fact that VA loans are much easier to refinance.

And so because VA loans are easier to refinance, those prepayments are going to be quicker on average. So going back to prepayments and the duration of the loan, borrowers can refinance much easier, VA loans much easier.

And so the lifespan of VA loans is shorter on average.

Kevin Foley: 00:26:00

So that's interesting. So even though VA and FHA loans kind of end up in the same place, they all sort of get bucketed together when they're sold.

That's sort of the reason why we might see FHA pricing a little bit better than VA pricing, just because vas are easier to prepay or maybe more likely to prepay.

Jim Glennon: 00:26:22

Yeah. Historically, you would see VA and FHA pricing price very close together or with a small price adjustment between the two.

But over time, you're going to see, if you're not already seeing it, those two prices deviate quite a bit.

And even at the granular level, FHA of 200,000 versus VA at 200,000 and so on, and that's likely just to continue to expand like we're seeing in the world of conventional.

Kevin Foley: 00:26:47

might see going forward into: 2025

Jeff McCarty: 00:26:53

So, as Jim said, I think we'll get ever more granular. You know, you probably start to see more and more of those specified loan amount buckets.

So, you know, even a couple of years ago, it was loans less than $225,000. We've already seen that jump up to 275, 300, 325, 350,000.

You know, obviously as loan amounts increase, we'll start to see those buckets of rise with them. So I think those are the two main trends that we'll see.

Kevin Foley: 00:27:21

Awesome.

Well, thanks for helping me better understand this, guys, and breaking it down for me and excited to talk next week about the other part of the trend that we're seeing with more regulatory impact for pricing granularity.

Jeff McCarty: 00:27:37

Yeah, Kevin, thanks for joining us.

Jim Glennon: 00:27:39

Thanks, Kevin and Jeff. All right, Jeff, let's close this thing out. I'd like to thank our podcast crew. Thank you, Jeff. Thank you, Kevin. Thank you, Alex.

Jeff McCarty: 00:27:49

More great content in the coming weeks. Obviously the election coming up, so we'll be hitting on that in the next couple of episodes.

Also, want to follow up on a few things we talked about today.

So, you know, how do spec Payups, specified pool payups that we talked about, how do they make it all the way down to rate sheets and do they make it all the way down to rate sheets and at what level? So we'll talk about the how what the borrower and the loan officer sees in terms of some of those pricing components.

You know, also get into some of those other more policy based programs that we talked about, some of these new mission score products that you may have seen come from Fannie and Freddie. So a lot of really interesting content coming up.

Jim Glennon: 00:28:32

And we'll also talk about why you may have noticed that between lenders, sometimes pricing for some of these enhanced products, I can be different from lender to lender. That's it for today, gang.

Join us next week for another episode of Optimal Insights, where we'll continue to provide you with the latest market analysis and insights to help you stay ahead. Don't forget to follow us on LinkedIn for more updates and to access our latest video episodes.

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