Ok so thread of mortgage origination and securitization. trying to keep it simple so i might simplify some parts. do not be the jerk that pops in with some technicality correction or edge case, that's how people get blocked.

Here's the basics of how mortgage lifecycle works: you apply for a loan, an originator will arrange for that loan, make it, and then sell it to fannie or freddie mac. for ginnie its different bc they dont buy, they guarantee but the end result isnt that much different in abstract

first:everything about this market is stupid and anachronistic, so just like accept it for what it is. the market as a whole is quoted in coupon terms. consumer rates operate in 1/8th of 1% coupon increments and groups of loans and bonds backed by loans in 0.5% coupon increments

your rate as a consumer right now if you are a credit-worthy borrower and are taking a loan that is inside the GSE limits for your geography (a conforming loan) then you might be paying 2.75%-3.125%. that loan. That's your loan's rate.

this morning the fannie mae comittment rate was 1.85. that means that they would pay par for a 1.85 coupon. the difference between those two are the economics that cover a mortgage's servicing (collecting/processing payments, handling non-payments etc) and the originator's profit

a normal spread between a consumer rate and the commitment rate is around 0.4% but is currently closer to 1.2%. this means that the company originating the loan (paperwork) is making A TON OF MONEY by writing you a 3% loan and selling it to fannie at 1.85% https://twitter.com/NewRiverInvest/status/1290550554603618304

the loans are pooled into big groups that have certain common characteristics (time of underwriting and range of loan coupon). similar to treasury features, there's ac active market for bonds made of loans that dont even exist yet. they are just commitments to buy tomorrows loans

now here is the thing... when you have a mortgage, you can pay it early at any time. that's what happens when you move, when you refinance, or when you send more money than you owe. This is called a prepayment option, and the borrower is long an option, so the lender is short

this means that if you have a bunch of loans that have a big coupon, they might trade at a price over par in the market. it also means that if someone refinances you could pay $103 for a loan that ends up being repaid back at $100 and you didnt make up the premium you paid

some people are OK with that risk and some not. so what happens is that high $ price loans go to people willing to take more risk or undergo structuring of that prepayment risk by creating CMOs, collateralized mortgage obligations which shift who takes the risk of prepayments

banks are the biggest buyer. banks buy bonds where (planned amortization class.. google it) they pay close to $100 to not risk losing money and they get a little lower coupon but a more predictable bond where the life of the bond is more predictable, which is important to them

of course if banks take less risk, someone else has to take more. the second player is whoever absorbs the "support" this is the piece that risks getting prepaid earlier or, if there is no prepayments, ending up holding a bond for longer than they expect

the support buyers get more coupon in exchange for taking the risk. groups vary but generally you are talking about people with more regulatory leeway and capital treatment. insurance type places and large sophisticated institutional buyers is a good simplification

for bonds where the loans have much higher coupons than the coupon on present day bond selling it par (the current coupon) after splitting it into less risky pieces with lower coupon and a higher risk piece with a slightly higher coupon, you might still have coupon remaining

this is called an Interest Only (IO) tranche. you are buying a piece of the interest portion of the coupon *only*. that means if you have an IO backed by 5 loans and all 5 people pay early (refinance, default, sell house etc) then thats it you lose all your money instantly

obviously this part is super risky, so it only really gets sold to sophisticated investors that specialize in the field.. mostly hedge funds. it is often used as a bet that benefit if interest rates increase (because then less people would refinance).

ok lets go back a little bit. remember the part about servicing your mortgage? When your originator gives you the loan they get to retain a Mortgage Servicing Right (MSR) which, for the life of the loan, pays them x% of the remaining balance of the loan in exchange for servicing

this is basically like an IO except if you stop getting paid you can stop doing the work, so it somewhat mitigates some of the risk, but the truth is most originators expect to spend less money servicing than they get every month, so getting a prepayment is a loss to them too

which brings me to my ultimate point: the entire mortgage market is essentially the same as a big big covered-calls fund that always has to be invested, some people benefit when things get called because you have to do more trades, some people because they bought the calls

in this analogy the hedgefunds and sophisticated investors and mortgage servicers sell the calls, the mortgage borrowers buy the calls, and the originators (sometimes independent and sometimes part of a bank) are the brokers and market-makers.

so when anyone interferes to raise or lower rates there is very clear winners and losers. if fannie mae / freddie mac hurdle refinancing, they will be bailing out hedge funds and banks and sophisticated investors at the cost of normal people's chance lower their monthly payments

the adjustment today was a loan level price adjustment of 0.50% that means that if Fannie/Freddie were paying $103 (pretty close tbh) for a refi loan originated, starting Sept 1 they will pay $102.50, so originators get a kick in the shins for everything that wont close before

and starting tomorrow you’ll see originators raise the rates they offer for refinances vs their new purchase loans, so they can prioritize purchase loans with better economics (probably the intended effect). by how much? who knows. but MS estimates the 50bp LLPA is worth 12.5bps

that 12.5bp is REALLY FUZZY THOUGH. a 30y loan has a weighted average life of about 15 if no prepayments, but depending on your prepayment expectations that could be as short as 6m (the min time before next refi window) or 7y assuming normalish turnover of loans (moves, defaults)

so 12.5 just means they think that on average new refi loan pools trade as if they have an expected duration of 4 years. thats just an assumption, though. and its unknown how much originators will absorb and how much they will pass down to the consumer

if its not obvious, longer expected lives will impact rates less and shorter more. so if lending rates decline further the hurdle in bp will turn a little higher on the higher coupon loans and vice versa. anyways thats enough mortgage brain damage for today

pour one out for the borrowers who will save less money, paperwork hustlers and call center sales people and municipal record keepers that will see their transaction flow impacted and make less money from transaction flows. the losers in this decision are not “wall street”