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By John Baity
The mortgage market is as competitive as ever.
Ten or more years ago, members of the Federal Home Loan Bank
of Boston "owned" their local market for residential
one- to four-family mortgage originations. Today, however,
a spate of new competitors — mortgage brokers, broker/dealers,
non-bank banks, and online competitors — have emerged
and invaded the banking domain. For members who stake their
financial prosperity on the mortgage business, this trend
is unsettling and requires solutions.
A chief operating officer at one of our members recently
commented: "Our mortgage folks don't like change, but
we need to pay attention to anything we can do to make our
originators more competitive." Another senior loan officer
quipped, "Mortgage brokers — they're everywhere,
they're taking our business."
In today's highly price-sensitive mortgage market, one of
the weapons that a Bank member has — which most non members
(for example, mortgage brokers) do not have — is credit
quality.
What does it mean to use credit quality as a weapon? We mean
that Bank members can enhance the price received for their
loans sold into the secondary market by retaining a portion
of their credit quality. Since that credit quality has been
excellent, the price received translates into greater profitability
and market share.
Mortgage Partnership Finance® (MPF®) is a credit-risk-sharing
program that rewards members for excellent credit quality.
This is how MPF generates value for our members:
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When a Bank member sells a loan to the Bank, the strike
price has generally been higher than the alternative conduit
because no charge is made for the guaranty fee.
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In addition, for sharing a portion of the credit risk,
members receive a credit enhancement fee, usually at around
10 basis points per annum, calculated by the unpaid principal
balance on sold loans.
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For most members, the combined all-in value of the strike
price and credit enhancement fee could be about 50 to
75 basis points. Can you afford to give up this value
if your expected credit losses are close to zero?
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The credit exposure that members share in the MPF program
is called the credit enhancement obligation. This is the
amount of contingent loss that must be shared by the member
to bring the rating on the sold loans to an AA-rated security.
The Bank member's exposure only kicks in after depletion
of the cumulative amount built up in a first loss account
set aside by the Bank, which grows at four basis points
per annum on the total balance of sold loans. Should a
loss be large enough to penetrate both the First Loss
Account and the credit enhancement obligation, the Bank
absorbs the residual losses. Member loss exposure cannot
exceed the total amount of the credit enhancement obligation.
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In summary, the member's credit risk is protected and
capped; as such, the member is only taking on credit loss
that might permeate the credit enhancement obligation.
It is important to keep this risk exposure in perspective.
Review of mortgage losses on mortgage loans held in portfolio
or sold to the secondary market reveals that in recent years
it has been either nonexistent or miniscule. In addition,
members have some control over credit risk by determining
what types of fixed-rate loans they sell into the MPF program.
Members currently not utilizing the MPF program would benefit
from asking themselves the following two questions:
1) Do you know how much value you are missing by not participating
in MPF?
2) Knowing what you know about your credit performance, can
you afford to leave behind that financial value?
Your relationship manager and MPF representative are available
to assist you in this analysis and enroll you in the program.
For more information call your relationship manager, or call
secondary sales managers Bill Dolan (Massachusetts, Rhode
Island, and Connecticut — 617-292-9691) or Mark Sullivan
(Maine, New Hampshire, and Vermont — 617-292-9672).
"Mortgage Partnership Finance" and "MPF"
are registered trademarks of the Federal Home Loan Bank of
Chicago.
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