Home-loan programs have proven successful for many credit unions. Their ability to provide competitive rates and their reputation for high-quality service, combined with members’ high demand for mortgage products, creates an ideal environment for credit union mortgage programs. But credit unions that offer home loans also must manage the risk involved with carrying these portfolios on their balance sheets; namely, interest-rate, credit and liquidity risk. To help mitigate these risks, many credit unions turn to the secondary market.
This time of year, home-loan sales and mortgage loans typically increase. All signs point to rising home-loan sales this spring as usual – despite the continued interest-rate climb. In January, the ten-year Treasury was 4.34 percent, and currently it is 5.08 percent. With this rate hike, a mortgage loan originated in January and priced at par ($100) is worth only $98.50 today. Additionally, record-high real estate loan growth continues its trend from 2005, when total real estate loans represented 47.7 percent of total loans, compared with 40.9 percent a year earlier.
As a result of rising interest rates coupled with a booming housing market, more credit unions are selling loans to secondary market outlets. And, while selling conforming loans attracts the most attention, selling jumbo loans offers many of the same benefits and may make more sense being at a higher risk of negative convexity.
Although there are differences in the processes of selling these loan types to the secondary market, selling both conforming and jumbo loans is a smart move for credit unions looking for proven balance-sheet strategies.
Conforming loans and the secondary market
Many credit unions find selling their conforming home loans to Fannie Mae and Freddie Mac a good strategy because it frees up liquidity to make additional loans. And, perhaps more importantly, both Fannie Mae and Freddie Mac enable credit unions to retain loan servicing – thus, helping strengthen their member relationships.
Both Fannie and Freddie have divisions solely dedicated to serving credit unions, and their pricing is very similar. And, there are several real estate loan products that offer an automated underwriting process, the ability to deliver loans on a “best efforts” basis, and the option of various reporting/remitting options.
Jumbo loans and the secondary market
Selling jumbos offers credit unions important benefits as well – many that have a direct, positive impact on the bottom line. Understanding the differences in processing can help credit unions smoothly sell their jumbo loans. However, sometimes the differences can seem daunting. For example, most jumbo investors don’t allow credit unions to retain servicing, bringing about an understandable fear they quickly will begin cross-selling to their members. But this isn’t true with all jumbo investors. The key for credit unions selling jumbo loans is working with a secondary market investor that is focused on credit unions and member retention.
Similar to conforming loans, selling jumbos helps credit unions maintain good financial health. It can help clear the balance sheet, provide liquidity for other lending demands, manage interest-rate and credit risk, and withstand increased regulatory scrutiny of ALM practices. Another benefit of jumbo loan sales includes having access to unique automation tools, like Charlie Mac’s ExpressLock. To combat the effects of rising interest rates, ExpressLock is a Web-based method for credit unions to sell loan commitments almost immediately after locking the rate with the member, avoiding further price increases as well as interest-rate risk.
As with any prudent asset/liability management (ALM) decision, credit unions wanting to sell jumbo loans to the secondary market should consider several important issues:
Because jumbo loans serve a limited, higher-end member segment, investors offer fewer products. A typical prime jumbo investor will offer standard fixed and adjustable products in addition to interest first, balloons and construction-to-permanent products. Most also will offer Alt-A products and allow stated documentation, second or investment properties and no-income, no-asset options.
Underwriting jumbos involves some manual processes and added restrictions, understandable with the greater risk of assuming large loans. While the loans can be run through an automated underwriting system like Desktop Underwriter or Loan Prospector, there are limits related to the loan-to-value (LTV) ratios, credit scores, and debt-to-income (DTI) ratios. As loan amounts increase, the maximum allowable LTV will subsequently decrease. Conversely, as credit scores decrease, the maximum allowable LTV also will decrease. Each investor will have slightly different matrices and should carefully be reviewed before establishing a relationship.
Jumbo loans are priced using a risk-based pricing approach. For example, a member with a high FICO and low LTV for a home purchase will be less risky than a member with a lower credit score and higher LTV for a cash-out refinance. Most investors will have adjustments to the price of a loan including FICO, LTV, property type, documentation type, occupancy type, loan amount and state. Knowing these adjustments up front will help the loan officer offer the member an interest rate that will receive an appropriate price on the secondary market.
Agencies offer servicing-retained programs that allow credit unions to keep the member relationship. Most jumbo investors, however, will force the credit union to sell the servicing and cross-sell the member in an effort to supplant the credit union as the member’s primary financial institution. Charlie Mac, as an example, is a credit union-only jumbo investor that allows credit unions to keep the servicing relationship with their member. They have a true servicing-retained program as well as a servicing-released program, which allows the credit union to capture the servicing-released premium (SRP); but rest-assured, their member is safe because the servicing is placed with a sub-servicer that private-labels it in the name of the seller. Charlie Mac also has an innovative program called servicing-maintained that lets the credit union sell the asset released to capture the SRP and act as the sub-servicer and service the loan as normal. The transaction is transparent to the member and the credit union actually will receive a flat fee to act in that capacity. Credit unions must identify an investor who will let them keep the servicing relationship in order to better serve their most important asset, the member.
Many credit unions take advantage of the best-efforts pricing the agencies offer and the flexibility it provides. Because a credit union will not be required to deliver the loan if the member does not close, the price is less attractive than mandatory delivery. Most jumbo investors utilize mandatory delivery to both offer the best pricing to credit unions and manage their interest-rate risk. Although the credit union will benefit from the more attractive price, if the loan is not delivered to the investor it could be subject to a pair-off fee (usually 25 basis points).
Credit unions that sell jumbo mortgages will deliver a slightly expanded collateral package and typically will ship credit files for review by the investor until a delegated underwriting status is achieved. This extra scrutiny offers protection to both the credit union and the jumbo investor.
- Reporting and remitting
Because most jumbo loans eventually will be securitized, reporting and remittance is on a scheduled/scheduled basis. Credit unions hold the funds remitted by their members and report the previous month’s actual activity along with the current month’s scheduled activity. While in rare situations this may result in a credit union having to forward funds on behalf of a member who has not made a mortgage payment, a credit union will benefit from roughly six months’ float on their servicing portfolio since remittance of funds to the investor is not typically due until the 18 th of each month.
Again, because jumbo loans will be securitized, both the loan and the credit union are subject to SEC regulations, including Sarbanes-Oxley and Reg. AB. Make sure the secondary market investor you choose will work with you to help your credit union prepare and meet these additional regulations.
When it comes to selling loans to the secondary market, credit unions have much to gain. While selling conforming loans is more commonplace, jumbo loans offer additional benefits that can create a positive impact to a credit union’s bottom line. The secret is working with the right secondary market investor – one who understands the credit union industry and the importance of retaining member relationships. By doing so, credit unions are best-positioned to capture a greater share of the mortgage market and serve their primary purpose: providing loans to members.
Charlie Mac is a CUSO and secondary market investor committed to helping credit unions minimize the cost of managing liquidity and maintain member relationships. Contact your corporate investment representative for more information.