So far in 2021 the mortgage environment has felt like a reversal of 2020’s anomalous events. Furthermore, as if hedging mortgage risk wasn’t complicated enough, 2021 has brought some interesting updates and trends—the outcome of which could make hedging and investing in mortgage debt more challenging. Below are key highlights on current market conditions and regulatory implications.

Higher rates, tighter spreads

Over the last year, the 10-Year U.S. Treasury rate has increased substantially. Currently, the rate resides at 1.44%, which is 71bps higher over the year and 52bps higher year-to-date (YTD). However, according to the Freddie Mac Primary Mortgage Market Survey® (PMMS), the 30-year mortgage rate is actually lower by 22bps over the last year, although it is 29bps higher YTD. While this may seem counterintuitive, this result means a tighter primary/secondary (P/S) mortgage spread, which was widely expected. The P/S spread measures the primary mortgage rate, currently around 2.96% according to FHLMC PMMS, less the yield on a par-priced mortgage-backed security (MBS). Currently the P/S measures 1.18%, down 41bps from one year ago when it was significantly wider and is much closer to its long-run average of around 1.10%.

Premiums and pay-ups shrink

The golden age of mortgage gain-on-sale premiums may be behind us. While the P/S spread is still a bit wider than pre-pandemic levels, it has largely returned to normal. And not just that – pricing from Fannie and Freddie has as well. The premium for a primary-rate 30-year mortgage is much lower than mid-pandemic. Premiums are down anywhere from 1 to 3 points as 104-handle prices become rarer. Additionally, pay-ups have collapsed—a reversal of their widening into 2020’s refinance boom. Pay-ups are characteristics of mortgage pools that investors “pay up” for, such as low loan balance (LLB) pools. LLB pay-up values are a form of call protection, or prepayment protection since the incentive to refinance is lower. As such, they tend to move directionally with rates. As rates decrease pay-ups would be expected to increase as call protection gets more valuable in a less certain prepayment environment. When rates rise, the refinance share of prepayments falls, and prepayment speeds overall become more predictable as they become largely a function of the housing turnover rate. Indeed, investors and hedgers alike are seeing their pay-ups decline sharply as the market is becoming more comfortable with today’s prepayment environment. Figure 1 demonstrates this trend visually.

Figure 1: 85K Max Loan Balance Pay-up on a Primary-Rate 30-Year Mortgage











Source: ALM First, Fannie Mae

Lending and profitability

With tighter spreads and shrinking premiums, the outlook for profitability is lower relative to 2020’s results. As a lender, if you made it through March/April of 2020 then chances are you had a banner year. Such is the case for many of our clients at ALM First Financial Advisors. However, since our clients are predominantly depository lenders, 2021 has brought on a whole new challenge: excess liquidity. Deposit growth has far outpaced loan growth on most balance sheets, leading to pressure on net interest margins and capitalization ratios. Working with institutions on which loans it makes sense to sell, if any at all, has been top of mind lately. Recent surveys have also shown a sizeable shift from refinance to purchase business. Currently locked loans across our client base are a 50/50 split between refinance and purchase, relative to 75% refinance one year ago. While overall loan demand for GSE-eligible mortgages seems to be relatively strong, falling refinance business along with the need for loan demand has led to overall smaller hedged pipelines for our clients.

FHFA: political or not?

Currently regulated by the Federal Housing Finance Agency (FHFA), Fannie Mae and Freddie Mac have issued several seller/servicer guidelines over the past year under Director Mark Calabria, some of which are significant. However, a pending U.S. Supreme court case, Collins v. Yellen, has potentially significant implications for the mortgage debt market and the policies therein. This case deals with, amongst other things, whether the FHFA’s single directorship structure, who may only be removed “for cause” and is exempt from the congressional approval process, violates the separation of powers. If ruled unconstitutional, this would allow the White House to replace the FHFA director at will and may even lead to the reversal of some policy decisions made under its “unconstitutional” structure. Two policies relevant to seller/servicers include:

  • Second home and investment property mortgage cap of 7% of total single-family mortgage acquisitions on a 52-week rolling basis.
  • Cash window cap of $1.5 billion per lender on a 4-quarter basis.

While neither are particularly impactful for smaller depository lenders, both have implications for the MBS market overall. These rules may lead to more volume to private investors. The cash window cap, done to “provide small lender protections”, would force many large lenders to securitize their own pools, thus increasing the number of Agency MBS issuers. The cash window is operated to provide “non-discriminatory” (e.g., not volume-based) pricing for lenders. However, even lenders below the $1.5 billion cap could benefit from securitization, as it can, assuming proper preparation, allow for better performance. Lenders control their pricing a little more when securitizing as the economics of the transaction come directly from the bond market as opposed to a pricing sheet, which are subject to more behind-the-scenes levers.

Going forward

Although rates have seen a strong run-up this year, the 10-Year rate has stabilized, and broke to the downside this month after falling below 1.5%. While the mortgage market in general is expected to decline, given the shift to purchase away from refinance, consumers haven’t added much debt and economic activity is expected to continue its rebound. If this occurs, it will bode well for depository lenders, and many are preparing for an expected uptick in loan demand.

Alec Hollis, CFA
Director, ALM Strategy

Alec Hollis joined ALM First Financial Advisors in 2012.  As a Director for the ALM Strategy Group, Alec performs asset liability management strategy research for financial institutions. He also implements firm-wide ALM modeling procedures, and assists in the execution of client balance sheet hedging programs.

Alec holds a bachelor’s degree in finance from the University of Notre Dame, as well as the Chartered Financial Analyst (CFA) designation. 

For more detailed information on the mortgage market or to learn how ALM First assists depositories with mortgage pipeline hedging, please contact visit

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