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- TOUR DE MTG FINANCE – ONE THING! UNDERSTANDING HOW COUPONS WORK.
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UNDERSTANDING HOW MBS COUPONS WORK
I want you to understand this so much that this is the only article I am writing today.
READ THIS TO HELP EXPLAIN HOW RATES INCREASE OR DECREASE.
Ok, so when I say MBS and coupons and Fibonacci levels and all that jargon that makes peoples head spin the one thing that is important to grasp is knowing what MBS coupon you should be looking at because the coupons trade differently depending on the mortgage product and the yield you are providing for your borrower.
Here is an example. Last week the 2.5% coupon went to pure crud to levels we have not seen in quite some time. This means your rates increased last week quite significantly.
We monitor the 2.5% coupon because that is what a lot of your conventional mortgage products have traded in rate wise. It is Wall Streets version of the same rate sheet you look at every day.
Last week we lost 133 bps in the 2.5% coupon. I am going to now list last weeks numbers for the different coupons and then explain why this is important.
2% UMBS Coupon – LOST 155 BPS
2.5% UMBS Coupon – LOST 133 BPS
3% UMBS Coupon – LOST 67 BPS
UMBS is another word for Conventional Loans MBS
2% GNM2 Coupon – LOST 158 BPS
2.5% GNM2 Coupon – LOST 105 BPS
GNMA2 is another word for Ginnie Mae MBS
Now that we know how much they lost last week and as an easy way to remember 1 BPS in loss or gain equates to $10 in payment (interest) for every 100K in loan size. So, if you are selling in the 2% UMBS coupon that equates to $1,550 lost per 100K in loan size if your loans were not locked. $10 x 155 BPS per 100K or to get real technical it is $1.00 per BPS for every $10,000 in loan size.
Now, you can see quite the difference between the 2% UMBS Coupon and the 3% UMBS Coupon. Interesting huh! 155 BPS lost minus 67 BPS lost = 88 BPS difference or $880 per every 100K in loan. That is a BIG difference to the customer AND to you and is why it is important to know what coupon your mortgage product is being delivered from.
The main point to remember on above is you have conventional products MBS trading and you have government products MBS trading. As you can see the difference between the GNM2 which just means FHA and VA MBS Ginnie Mae coupons was 53 BPS. So which ones should you be be watching?
To understand how you can translate MBS trading to your rate sheet you must understand a few things.
First, lets take the 2.5% UMBS coupon which is the coupon most people have been monitoring for quite some time. On Friday it closed out at 100.56. Well, what the heck does that mean? This is where I totally lost Lucy. As I began to explain this Lucy literally went to the kitchen, baked a pie crust, filled it with whip cream, came back to my office and threw the whip cream pie right in my face and smothered my head in it. Then said, ok I don’t feel so dumb now that you have pie on your face. That Lucy is crazy!
(For those of you who do not know, Lucy is my imaginary friend I put in my articles solely to entertain myself)
Ok, so lets say you see the 2.5% coupon closing at 100.56. What that means is that on Wall Street where the traders are trading all day long they are selling MBS (Mortgage Backed Securities – aka your loans that you close in bulk). If an investor lets say is investing $10,000 then that investor if buying our MBS at that moment will receive a fixed return on their money of 2.5% hence the word coupon. Coupon only means the rate of return an investor gets on an investment product. Since it is in the bond market it is a fixed rate of return.
Ok, so the coupon is how much the investor gets. Well, if the investor wants that 2.5% rate of return they must pay up to get it. They would have to pay .56 or 56 BPS in premium to get that kind of rate of return so they would have to pay $56.00 to get that rate. If they invest 100K they would have to pay $560. This is the same concept as you raising or lowering your rate and your borrower getting a credit or having to pay a discount. The exact same premise.
Now, you must understand this. This is what us lenders who are selling to Wall Street get. This is not what you get for selling that rate. This is important to understand as well. This is what the coupon is trading at but this is highly unlikely what the lender is getting specifically. It depends on volume, lock in periods, prepay speed history, who you are selling to, hedging costs, overhead and many other things. This is why all lenders do not have the same rates. Therefore, for the rest of this article the .56 yield is just an indicator of what the yield is producing for a specified rate.
In order to see how the 2.5% coupon yielding .56t equates to current rates we must add servicing fees, gfees, LLPA’s, gain on sale plus all of above to that in order to get to the pricing you see on your rate sheet.
The point to get here is the 2.5% coupon only paying 56 bps or on your rate sheet 100.56 well there is no way anyone can make any money on that small of a margin. This means that we must go to a higher coupon so that same investor will pay us more money in order to be able to pay you. The higher the rate of return you offer an investor the more money they will pay you upfront to get that rate of return.
That brings us to knowing what coupon to be watching. So the 2.5% coupon closed at 100.56. It was fine before because last Monday it was trading at 101.89 which means that same investor who wanted the 2.5% had to pay us 1.89% of the loan amount to get that rate vs the .56% of the loan amount to get it now.
So, for lenders to make money we have to charge a higher rate so that investors will pay us enough money to make money and to pay you.
Ok, so hopefully you are figuring out that part.
Now, here is the next BIG important thing to understand.
The coupon is only the Wall Street investors yield. For every loan you close either Fannie Mae, Freddie Mac, FHA, VA or USDA guarantees or insures that loan. Well guess what, they want to get paid for that. So the typical fee the agencies charge is .25% to .375% in interest rate. For the sake of easiness lets just assume the guarantee fee is .25% in interest rate.
This means the 2.5% coupon that closed at 100.56 at 2.5% is now 2.75% at 100.56 because the gfee aka the guarantee fee paid to the agencies to insure or guarantee that investor costs the borrower .25% more in interest rate.
Well guess what, someone has to service that loan. In case you did not know the people who own the loan are not the same as the ones who service the loan. Wall Street investors aka your mutual fund, 401-k and a ton of other investments you have included mortgage backed securities which means you likely own a piece of the American mortgage debt. Mortgages are owned by 100’s of thousands of different investors.
So, in order to service loans servicer’s such as Flagstar Bank service it for the investors and the fees range but for the sake of easiness it is usually around .25% in interest rate.
Now, that 2.5% coupon to the Wall Street Investor PLUS the .25% in interest rate to the guarantor of the loan PLUS .25% in interest rate to the servicer now brings that 2.5% paying 100.56 to 3% paying 100.56.
Ok, so now that we have that figured out it gets much easier. Likely if you were to look at your rate sheet you will not see 3% paying you 100.56. Well, you have LLPA’s for credit scores, loan sizes, product types and of course margin to lenders to cover all the costs I mentioned earlier. This part is not easy to figure out but thinking about .75 higher in rate is a standard you can kind of look at but again it is impossible for you to figure out what it is due to the volume of LLPA’s across the board including the agencies.
The important part to understand is if an investor is investing money and not paying anything to get it then we have no way to pay you.
Here is how the week ended with the same coupons above but what the investor was giving us or costing us for that rate.
2% UMBS Coupon – 97.95
2.5% UMBS Coupon – 100.56
3% UMBS Coupon – 102.81
2% GNM2 Coupon – 99.11
2.5% GNM2 Coupon – 101.20
Now, go back to the top and see how little the 2% coupon losing what it did matters that much or the 2% GNM2 Coupon. They did not matter as much because we were not selling to that coupon likely.
We should likely now be monitoring the 3% UMBS and the 2.5 – 3% GNM2 Coupon. The 2.5% is still viable for very low borrower paid rates or when you are charging full origination fees but if making your money in yield then the 3% is the new ball game.
I TRULY HOPE THIS HELPS. LUCY GAVE ME A BIG HUG AND HAD A SMILE ON HER FACE : )
If you want to receive morning updates each day when rates come out to know where we are in the MBS market just text “I’M IN” to 251-428-1564.
Turn Times As Of This Morning Lookin Good!
| TURN TIMES | Purchase | Refinance |
| Business days | business days | |
| Conv Non-MI | 1 | 1 |
| Conv MI | 1 | 1 |
| FHA/VA | 1 | 1 |
| USDA | 1 | 1 |
| Jumbo | 1 | 1 |
| Conditions | 1 | 1 |
