amsf-mba6_19_08final
TRANSCRIPT
Citigroup Treasury Risk ManagementTreasury Risk Management
Alternative Minimum Service FeeAlternative Minimum Service FeeReducing Risk in Hedged MSRReducing Risk in Hedged MSR
June 19, 2008Mark Friedenthal
Citigroup
MBA Secondary Marketing Committee
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
MSR returns are extremely volatile and, at times, prohibitively costly to hedge.MSR is capital intensive, requiring 17.2% bank regulatory capital (nearly 11x the capital of agency MBS). Non-bank capital requirements may be greater.Traditional MSR, as a Level 3 asset, lacks valuation transparency. It is difficult for regulators, independent risk managers, and analysts to form consistent opinions as to accuracy and fairness of value.Capital intensive investment and volatile returns have prompted exits from the mortgage business, leaving the GSEs with concentrated risk to large servicer default.
Servicer compensation based on constant percentage (e.g. 1%) of all of the cash-flows of each loan. As such, the service fee would be based on BOTH principal & interest, rather than an interest-only strip. In turn, it would look like 1% of the MBS pool that is created (plus ancillaries).
Proposal
Issues
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Mechanics
Servicer (AMSF) is in similar position to MBS investor.
Prepayments are applied on a pro-rata basis.
Requires complete conversion to new AMSF servicing to prevent adverse selection on the part of lenders.
Excess servicing still exists as an alternative to higher delivered coupon and agency g-fee buy up grids.
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
0.25% g-fee
AMSF(1% P&I)
0.25% excess
Alternative Servicing Fee Calculation: 1% of MBS Cash-flowsBoth MSR value and total loan value remain constant
$ 1bn UPB x 98 px = $980mm6.25%
Agency Loan
6.25% Agency Loan
Fee Calculation[1%] of MBS cash-flows
Traditional
AMSF$990mm UPB x 100 px = $990mm
MSR = $10mm UPB x 100 px + ancillaries = $12.5mm(MSR= 1% of par bond + 25bps for ancillaries)
Total Value = $1.0025bn
MSR = 125bps x $1bn = $12.5mmExcess = 100bps x $1bn = $10mm
Total Value = $1.0025bn
0.25% g-fee
5.5% MBS
0.25% msr
6.00% MBS
AMSF Construct
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Cash-flows – Example
10.93.65011.24.94011.66.83012.510.52013.313.81514.619.31017.029.2521.748.70
1% of MBS25 bpsCPR
Stable Service Fee Income means reduced risk
Prepayment Speed
$1bn UPB, 6.25% note rate, 6.00% MBS
Total Service Fee($MM)
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Constituent’s Perspective
ServicersReduced RiskReduced Hedge ExpensePossible Reduction in regulatory capitalImproved valuation transparency and market liquidity
Promotes industry Stability
InvestorsReduced mortgage rate volatility (current coupon)Lower gross WAC/coupon deliveredIncreased supply of higher coupon TBAImproved valuation transparency and market liquidityConcerns about servicer solicitationConcerns about market liquidity
Regulators/Analysts/Shareholders/Independent Risk
Improved transparency in valuationReduction in servicer net exposure
Consumers
Expected more competitive pricing
GSEs
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Less Reactivity to Interest Rates and Less Duration to Hedge
-5
-4
-3
-2
-1
0
1
-150 -100 -50 0 50 100 150
Interest Rate Change
10-Y
r Equ
iv S
horte
d fo
r Hed
ging
Servicing Strip Off 5.5s(Equiv Mkt Val)1% of 5.5 Passthrough
AMSF duration is less than 25% of traditional interest-only servicing.
AMSF convexity risk is less than 20% of traditional interest-only servicing.
MSR Volatility Reduction- Traditional MSR (IO) Volatility = 40% (1 σ/yr)- AMSF (MBS) Volatility = 5% (1 σ/yr)
-50
-40
-30
-20
-10
0
10
20
-150 -100 -50 0 50 100 150
Interest Rate Change
% C
hg in
Val
ue
Servicing Strip Off 5.5s
5.5 Passthrough
Source: Citi. Source: Citi.
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Prepayments
The size of the servicer’s investment (traditional disincentive) does not materially influence prepayment speeds.
Collateral characteristics best explain prepayment behavior.
25 bp servicing fee 6.0% coupon illustrates that gross wac is more influential than loan size, credit score, and servicer investment combined!
Fannie Mae 2006 Orig Yr Speeds by Servicing Fee
0
5
10
15
20
25
25 37.5 50 62.5 75 87.5Servicing Fee (bp)
6-M
o C
PR (%
)
6.0% Net Coupon6.5% Net Coupon
6.0% Net Coupon 6.5% Net Coupon
Sfee (bp) LoanSize LTV (%) CrdScore LoanSize LTV (%) CrdScore25 220 70 731 195 76 711
37.5 207 73 722 167 77 71050 191 73 722 164 79 704
62.5 194 75 717 157 81 69675 198 76 712 157 81 689
87.5 189 78 700 183 81 689
Source: Fannie Mae, CPR&CDR Technologies, Citi.
Source: Fannie Mae, CPR&CDR Technologies, Citi.
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Will prepayment speeds on premium bonds increase?
The overwhelming majority (90+ %) of refinances are initiated byindividuals/parties with no change in incentives due to AMSF.
- Borrowers- Loan officers- Mortgage Brokers- Correspondents- Competitors (other servicers)
Servicer specific prepayment data is widely available. Negative publicity for servicers with fast speeds serves as a deterrent to excessive solicitation.
- Capitalized value of ancillaries also serves as some disincentive for solicitation.
The gross wac (for a given pass-through coupon) will be approximately 25bps lower with AMSF, decreasing borrower refinance incentives and slowing speeds.
Data shows that prepayment speeds are not correlated to the size of the servicer’s investment (disincentive to refinance).
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Additional Benefits
Possible reduction in Regulatory Capital, commensurate with riskreduction.
Price Transparency – Asset will resemble Agency MBS (plus ancillaries), which have observable market prices.
Reduced probability of servicer “blow-up”.
Servicer will focus on long-term operational efficiency instead of hedging short-term P&L.
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
What will happen to TBA liquidity?
Pass-through market already differentiates by WAC, WAM, average upb, geography.
- The largest contributing factor to prepayment behavior is gross wac.
Prior changes to TBA market have been successfully transitioned.
- GNMA II base MSR reduced from 44bps to 19bps.
All new securitizations would be serviced in this new (and uniform) manner, eliminating the ability for “cherry picking”.
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Will non-agency securities be serviced using AMSF?
Will gain on sale accounting treatment change?
Will safe harbor tax status change?
The scope of this initiative begins with all Agency products. However, servicers may incorporate this new standard in to public and private non-agency securitizations in the future.
Preliminary evaluation suggests that accounting treatment will remain the same.
Preliminary tax evaluation suggests that the safe harbor treatment remains in effect with AMSF.
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Next Steps
Validate Accounting and Tax preliminary conclusions.
Work through Mortgage Bankers Association to flesh out logistics.
- Is 1% the appropriate size servicing fee?
- Should all products have the same fee?
- What other operational changes need to be made?
Work with SIFMA to gain investor support.
Include OCC, FRB, FDIC, and state regulators in development process.
Citigroup Treasury Risk Management
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Alternative Minimum Service Fee
Co-Sponsor Contacts
Mike Carrier
Mortgage Banker’s Association
(202) 557-2870
Mark Friedenthal
Citigroup
(212) 559-0989
Kirstin Hammond
Flagstar Bank
(248) 312-5780
Andrew BonSalle
Fannie Mae
(202) 752-3747
Franklin Codel
Wells Fargo
(515) 213-6508
Rich Bradfield
PHH Mortgage
(856) 917-0107
Mark Hanson
Freddie Mac
(571) 382-3910
Gordon Roder
AmTrust
(216) 588-5891
Mark Engman
US Bank Home Mortgage
(414) 773-3838