Troy Baars: Market Volatility Drives the Need for Speed in GNMA Spec Pool Formation
Troy Baars is president of mortgage hedge advisory firm Vice Capital Markets, Novi, Mich. Reach him at email@example.com or (248) 869-8100.
While there is a tremendous benefit to adding Ginnie Mae specified (spec) pools as part of a diversified execution strategy, lenders cannot continue to operate as if it’s business as usual when faced with the current volatility in the mortgage-backed securities market. Instead, speed must become of the essence, and lenders need to move as quickly as possible while monitoring the MBS market closely to continue effectively utilizing this strategy and maximize their secondary profitability.
Just as a quick refresher, spec pools are pools of loans that all share common characteristics. As a result of these shared characteristics, investors can more accurately forecast the future performance of those loans, particularly in regard to prepayment risk, and are thus willing to pay a premium, also known as a pay-up, for the pool. For example, low-balance loan pools (i.e. balances under $225K) are often particularly attractive to investors because of the reduced incentive to refinance these types of loans, thus resulting in a lower prepayment risk.
When demand is high, these spec pools often trade several points above the standard MBS, indicating that investors are willing to pay a premium to acquire these loans. However, when the trading price of these types of pools drops, the value of prepayment protection is not as high, making it no longer worth a premium to the investor to protect against early prepayments.
Once formed, these pools must be certified, which can take anywhere from three to seven days. Thus, with the recent market swings, it has not been uncommon for lenders to structure a specified pool and send it to be certified, only to find out that the pay-up that was there just a few days earlier no longer exists. As a result, these lenders get stuck with a pool that may trade worse than that of a normal multi-issuer pool. In February, lenders were getting pay-ups between 50 to 125 basis points on Ginnie Mae pools of 2% coupons. However, that pay-up fell to zero in early March. As such, lenders that were not watching the market closely may have ended up certifying pools that traded negative.
There has always been risk involved when forming spec pools, and the current market conditions are exacerbating that. However, this does not mean that lenders should abandon the strategy entirely. Instead, lenders need to focus on forming these pools as soon as possible and locking them in prior to certification to take advantage of current pay-ups while they exist. Early action and eagle eyes on market movements are lenders’ best defense in spec pool formation.
Even with the record profits lenders achieved in 2020, this, as they say, is a new year, and lenders cannot count on achieving similar results in 2021, especially as the market transitions from refinances to purchases. Thus, the financial contributions of a lender’s secondary market strategy become even more important to the health of an organization’s bottom line, and with the pay-ups that exist in the specified pool market, lenders would be well advised to continue engaging in this practice even amidst the current market volatility. However, to do so safely, lenders must be committed to their spec pool risk mitigation strategy, which means staying on top of market movements and making sure they’re moving quickly to sell while the demand exists.
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