FRBNY Economic Policy Review / December 2013 19
aecting them. In section 2, we begin with a general
discussion of the mortgage origination and securitization
process, and how originator prots are determined.
Here, we include a detailed discussion of the valuation of
revenues from servicing and points as well as costs from
g-fees, based on standard industry methods. Next, in
section 3 we use these methods to derive a time series of
average originator prots and unmeasured costs (OPUCs)
for the period 1994-2012, which largely reects the time-
series pattern of Chart 2. We then compare OPUCs and
the primary-secondary spread as measures of mortgage
market pass-through. Finally, in section 4 we turn to
possible explanations for the increase in OPUCs, including
putback risk, changes in the valuation of mortgage servicing
rights, pipeline hedging costs, capacity constraints, market
concentration, and streamline renancing programs. While
some of the costs faced by originators may have risen over
the period 2008-12, we conclude that a large component of
the rise in OPUCs remains unexplained by cost increases
alone, suggesting that originators’ prots likely increased
over this period. We then discuss possible sources of the
rise in protability. Capacity constraints likely played a
signicant role in enabling originator prots, especially
during the early stages of renancing waves. Pricing power
coming from renancing borrowers’ switching costs could
have been another factor sustaining originator prots.
4
2. M P
M O
2.1 e Origination and Securitization
Process
e mortgage origination process begins when a borrower
seeks a quote for a loan, either to purchase a home or to
renance an existing mortgage. Based on the borrower’s
credit score, stated income, loan amount, and expected
loan-to-value (LTV) ratio, an originator oers the borrower
a combination of an interest rate and an estimate of the
amount of money the borrower will need to provide up front
4
Importantly, this article focuses on longer-term changes in the level of
originator prots and costs, rather than on the high-frequency pass-through
of changes in MBS valuations to the primary mortgage market.
to close the loan.
5
For example, for a borrower who wants
a $300,000, thirty-year xed-rate mortgage, the originator
may oer a 3.75 interest rate, known as the “note rate,” with
the borrower paying $3,000 (or 1.0 percent) in closing costs.
If the borrower and originator agree on the terms, then the
originator will typically guarantee these terms for a “lock-in
period” of between thirty and ninety days, and the borrower
will ocially apply for the loan.
During the lock-in period, the originator processes the
loan application, performing such steps as verifying the
borrower’s income and the home appraisal. Based on the
results of this process, borrowers may ultimately not qualify
for the loan, or for the rate that the originator initially
oered. In addition, borrowers have the option to turn
down the loan oer, for example, because another originator
may have oered better loan terms. As a result, many loan
applications do not result in closed loans. ese “fall-outs”
uctuate over time and present a risk for originators, as we
discuss in more detail in section 4.
Originators have a variety of alternatives to fund loans:
they can securitize them in the private-label MBS market or
in an agency MBS, sell them as whole loans, or keep them on
their balance sheets. In the following discussion, we focus on
loans that are “conforming” (meaning that they fulll criteria
based on loan amount and credit quality, so that they are eligi-
ble for securitization by the GSEs), and assume securitization
in an agency MBS, meaning that this option either dominates
or is equally protable to the originator’s alternatives.
6,7
5
roughout this article, we use the terms “lender” or “originator” somewhat
imprecisely, as they lump together dierent origination channels that in
practice operate quite dierently. Currently, the most popular origination
channel is the “retail channel” (for example, large commercial banks that lend
directly), which accounts for about 60 percent of loan originations, up from
around 40 percent over the period 2000-06 (source: Inside Mortgage Finance).
e alternative “wholesale” channel consists of brokers and “correspondent”
lenders. Brokers have relationships with dierent lenders that fund their
loans, and account for about 10 percent of originations. Correspondent
lenders account for 30 percent of originations, and are typically small
independent mortgage banks that have credit lines from and sell loans
(usually including servicing rights) to larger “aggregator” or “sponsor” banks.
Our discussion in this section applies most directly to retail loans.
6
e fraction of mortgages that are not securitized into agency MBS has
steadily decreased in recent years, according to Inside Mortgage Finance:
while the estimated securitization rate for conforming loans ranged
from 74 to 82 percent over the period 2003-06, it has varied between
87 and 98 percent since then (the 2011 value was 93 percent). e private-
label MBS market has eectively been shut down since mid-2007, with the
exception of a few deals involving loans with amounts exceeding the agency
conforming loan limits (“jumbo” loans).
7
Our discussion throughout this article applies directly to conventional
mortgages securitized by the GSEs Fannie Mae and Freddie Mac; the process
of originating Federal Housing Administration (FHA) loans and securitizing
them through Ginnie Mae is similar, but with some dierences (such as
insurance premia) that we do not cover here.