TO TBAOR NOT TO TBA

C. Scott Riffle – Senior Vice PresidentApril 5, 2013

• Just say it, “Bonds are Dead!” (but don’t quote me)

– Didn’t that feel good?– Sometimes admitting the truth is half the battle

• Bonds NEVER worked that well…– Negative Arbitrage– Non-Origination Risk– Advancing of Cost of Issuance– GIC’s– Difficult Tax-Exempt Bond Program Restrictions– Market Risk Premiums for Local HFA’s

Take a Full Body Cleanse!

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• Gauge the Competitive Environment Is a State HFA lending in my Program Area? Is a Local HFA lending in my Program Area? Do Lenders in my jurisdiction have CRA/Subsidy programs operating?

• Chase, Wells Fargo, etc. Can the Local HFA compete or offer something unique?

• Systems in Place• Create Lender Loyalty• Create Program Loyalty• Innovate

• Do I Have a Servicer?

• Assess Upfront Costs and DPA Advance Requirement As much as $25,000 issuer counsel fee Must have cash resources to Table Fund DPA

• Estimate Loan Volume Is my lending area large enough? If YES, then TBA BABY!

Can I Compete in My Program Area?

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Background 

• Traditionally, most housing finance authorities (“HFAs”) have used the tax-exempt bond market to fund single family housing programs

Traditional bond market funding model broken (refer to Full Body Cleanse!)

• As a result HFAs are looking for alternative ways to fund mortgages and successfully complete their missions

• One program that has emerged uses the secondary mortgage market for funding Names used to describe similar programs include: Market Rate Program, Daily Pricing

Program, TBA Program, Turn Key Program

• A TBA Program functions like a traditional mortgage program TBA programs are not without risk

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Bonds issued (cost of funds)Mortgage rate published with

lenders

Lenders take reservations and loans

proceed through lifecycle

• In addition to a source of funding, mortgage revenue bond programs minimized interest rate risk for the HFA• If mortgage rates fell after the bonds were issued, the HFA could:

Lower issuer fee Call bonds (non-origination call)

• In either case, the HFA’s exposure to interest rates changes (interest rate risk) was minimal

• Using the secondary mortgage market introduces the HFA to interest rate risk

Mortgage rate published with lenders (daily)

Lenders take reservations and

loans proceed through lifecycle

Loans are pooled into MBS and sold into secondary market

(cost of funds)

Mortgage Revenue Bonds

Market Rate Program

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Interest Rate Risk

 

How it works:

1. HFA (or partner) set rate daily

2. Loans are originated through participating lenders

3. HFA (or partner) may choose to hedge against a change in interest rates

4. Master Servicer purchases loans

5. Master Servicer pools loans and creates MBS

6. HFA (or partner) purchases MBS at agreed upon price

7. HFA (or partner) sells MBS in cash market

8. Must generate sufficient proceeds from the sale of the MBS to pay program costs

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Market Rate Program: Mechanics

 

Setting The Mortgage Rate:• HFA (or partner) set rate daily (at least)

• Rate set to ensure pooled loans (MBS) can be sold at a price sufficient to pay cost of program

DPA, Lender Compensation, HFA Fee, Partner Fee

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Market Rate Program: Rate Setting

EXAMPLE:• Program costs equal 6 points• MBS needs to be sold at a price of at least 106 to purchase the loan and pay program costs• 3.5% GNMA MBS could be sold for a price of 106• HFA (or partner) sets mortgage at 4% with plan to deliver into a 3.5% GNMA MBS and sell the MBS at a

price of 106, covering program costs Coupons on GNMA I securities are always 0.50% lower than the mortgage rate to cover GNMA fees (0.44%) and

servicing fees (0.06%) Actual rate setting can be more complicated because of servicing proceeds - GKB has pricing models which generate

mortgage rates based on program costs and current MBS pricing

 

Rates not static, HFA needs a hedge• As rates move, so do the MBS sale prices

• Rates have the potential to move substantially between the time the loans are rate locked and

the time the MBS are purchased from the Master Servicer and sold into the cash market

Depending on the length of the rate lock, this can be up to 120 days

• This leaves the HFA open to potential losses

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Need to Hedge (TBA)

EXAMPLE:• Same terms as previous example:

Program costs equal 6 points, 4% mortgage rate and 3.5% GNMA MBS• At time the loan is rate locked at 4%, the 3.5% GNMA MBS sale price is 106• By the time the MBS is purchased from the Master Servicer, rates have gone up and the MBS can only be

sold for a price of 104• HFA would need to pay 2 points (106 minus 104) to make program whole• Purpose of hedge is to minimize any such losses

 

TBA Market• TBA stands for To-Be-Announced

• Allows for sale and purchase of generic MBS at a future date Settlement dates are typically the 21st of each month

• MBS must have a set of defined characteristics: MBS Type (GNMA I, GNMA II, FNMA, etc.)

Coupon

Loan Type (30-year Fixed)

• Ability to sell generic MBS at defined prices Lock in MBS sale price on date of rate lock

Ensures sufficient premium can be raised when selling the MBS to purchase the MBS and pay

program costs

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TBA Market

 • Okay, now that the TBA (hedge) layer is built in we are all set, right? WRONG!

• All loans that are rate locked don’t close: Once loans are rate locked, they move through the loan pipeline Not all loans that are locked close (fall-out)

• What is the risk to the HFA? The HFA (through the TBA trade) has already sold the MBS at 106 (previous example) If the loan fails to close, the HFA will need to buy the MBS in the cash market If rates have fallen, the cost of the MBS could be higher, let’s say 107 The HFA would then buy the MBS at 107 and sell it at 106 resulting in a one point loss

• The TBA market offers more efficient ways to deal with fall-out but the net result is the same

• This introduces “pull-through” risk: When hedging, the HFA must correctly predict the percentage of loans that are rate locked that will

actually close If pull-through is not predicted correctly, the HFA could suffer substantial losses from over or under

hedging

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Pull-Through Risk

The diagram below illustrates the steps in a market rate program.

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Flow Chart

HFA/Partner Sets Mortgage Rate

Daily

Lender Requests Rate Lock For A

Specific Borrower

HFA/Partner Hedges Against a

Change In Interest Rates By

Selling TBAs

Does Loan Close?

HFA/Partner Monitors Loan Progress From Lock to Close

Master Servicer Purchases Loan

From Lender

YesMaster Servicer Pools Loans and Creates GNMA

MBS

HFA/Partner Purchase GNMA

MBS from Master Servicer

NoAdjust Hedges If “Pull-Through”

Exceeds Expectations

Adjust Hedges If “Fall-Out” Is Lower Than Expectations

HFA/Partner Deliver MBS

into TBA Hedge or Cash Market

Cash Market Program

TBAProgram

LEGEND

The diagram below describes execution strategies for implementing a market rate program.

Is the HFA willing/able to

take on economic

risk?

No

Yes

HFA Sponsorship Model

HFA utilizes a partner to take economic risks and simply collects a program fee.

Does the HFA want/need

assistance in program

management?

Yes

No

HFA Shares Program Management

HFA works with an entity to monitor the program/

pipeline and assist in hedging but retains 100% of the

economic risk.

HFA Operates Program

HFA runs program on its own & accepts 100% of economic

risk. Only needs broker/ dealer to execute TBA trades or cash market on its behalf.

LOW RISK MORE RISK MOST RISK

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Managing A Market Rate Program:Which One Is Right For You?

 

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TBA Program Summaries

Information gathered from Program Guidelines and/or websites of the specific Program Sponsors. For Discussion Purposes Only.

Program Sponsor NM MFA Nevada Rural Hsg Aty OK Cnty HFA TDHCA SETH WashingtonName HERO Program 2013 Home At Last Turnkey Mtg Origination My 1st Texas Home (TMP-79) 5 Star Program Home Advantage Program

Income Limit $64,560 - $75,480 $97,500 $86,100 $60,100 - 85,900 for 1-2

depending on area.$30,245 - $103,040 depending on area

$97,000

Purchase Price Limit $243,945 - $342,585 $350,000 $214,925 $250,200 - $306,923 $250,200 none stated

DPA 3.50% 4.00% 3.50% 5.00% 4.00% and 5.00% 4.00%

Grant/2nd Grant Grant Grant 0% Interest, Deferred Loan Grant 0% Interest, Deferred LoanLender Comp 2.69% 2.00%, 1.50% (VA) 2.00%, 1.50% (VA) 2.00% 2.50%, 2.00% (VA) $1,500 min FICO 620 640 640 640 640 620max DTI not stated 45% 45% none 45% 45%

Program Sponsor IDA Phx/Maricopa IDA Pima/Tucson S Cal HFA C&C of Denver El Paso Cnty HA GA Urban Resid Fin Aty Dakota County CDA, MNName Home in Five Homebuyer Sol'n 2013 1st Home Mtg Metro Mortgage Plus Turnkey Mtg Origination HOME Atlanta 4.0 2012 1st Time HB

Income Limit $88,340 (all) $68,885 1-2 Persons = $99,360 - $109,800, 3+ Persons =

$111,515 - $128,100

1 or 2 Person: $91,1003 or more Person: $103,000

1 or 2 Person: $88,9003 or more Person: $103,700

1 Person $64,974, 2 Persons $74,256, 3 Persons $83,538,

1-2 person: $82,300, 3+ person: $90,530

Purchase Price Limit $300,000 none1 Unit homes, Non Target =

$673,615, Target = $823,308none $283,000 $374,268 $271,590

DPA 5%, Add’l 1% for Military 4% 4% 4% 4% 5%2.50% if over 80% AMI, up

to $10K with lower % to AMIGrant/2nd Grant Grant Grant Grant Grant Grant 0% Interest, Deferred LoanLender Comp 2.00%, 1.50% (VA) 2.75%, 2.25% (VA) 1.00% + $550 2.00%, 1.50% (VA) 2.00%, 1.50% (VA) 2.00%, 1.50% (VA) 2.00%min FICO 640 640 640 640 640 640 640max DTI 45% 45% 45% 45% 45% 45% 45%

• With the current interest rate environment, HFAs must find alternative sources of funds from mortgage revenue bonds to fund their single family housing programs

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Wrap Up

Interest Rate Risk

Risk Tolerance

Staffing

Local Market Characteristics

Pull-Through Risk

Political Environment

Relationship with Lenders

Relationship with Servicer

HFAConsiderations

• One option is to use the secondary mortgage market but there are a variety of considerations before HFAs enter this market

• HFAs must tailor their own programs to fit their unique circumstances

The information contained herein and in our presentation is provided for informational purposes only. It is not intended as advice nor does it create an advisor/client relationship between GKB Mortgage Markets Inc. or George K. Baum & Company and any readers or recipients (to the extent such relationship does not already exist). Readers should consult with GKB Mortgage Markets Inc. and George K. Baum & Company or their own advisors to discuss how these matters relate to their individual circumstances. Reproduction in whole or in part is prohibited without the express written consent of GKB Mortgage Markets Inc. and George K. Baum & Company.

This report was prepared from data believed to be reliable but not guaranteed by us without further verification or investigation, and does not purport to be complete. It is not to be considered as an offer to sell or a solicitation of an offer to buy the securities of the entities covered by this report. Opinions expressed are subject to change without notice. George K. Baum & Company may act as a principal for its own account or as agent for another person, in connection with the sale or purchase of any security which is subject in this report.

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Thank You!C. Scott Riffle, Senior Vice President303-292-1600riffle@gkbaum.com

Mr. Riffle has more than 22 years of experience providing investment banking and housing expertise to HFAs. Mr. Riffle is the lead banker for several TBA related engagements, including Pima County IDA, Tucson IDA, South Plains HFC and Nortex HFC. Mr. Riffle played a major role in the creation of the structure that won the NALHFA 2009 Single Family Excellence award for Jefferson Parish Finance Authority. He is also one of the firm’s experts in finding, negotiating and structuring the use of Community Reinvestment Act (“CRA”) dollars into housing bond and loan programs. The breadth of Mr. Riffle’s housing experience is further exemplified by the complex transaction he recently closed for the White Mountain Apache Housing Authority which resulted in $1.8 million in cash savings that funded housing construction and much needed job creation on the Fort Apache Reservation. Prior to joining the firm, Mr. Riffle served as a vice president with the Wall Street firm of Dillon Read & Co. where he served myriad municipal issuers in Colorado, Texas, Oklahoma and Louisiana. Mr. Riffle coaches junior baseball in his community and is a proud member of the Society of Mayflower Descendants.