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January 4, 2012

How The Mortgage Business Works. Simple right?

January 4, 2012

How The Mortgage Business Works. Simple right?

I periodically discuss AOT and recently got a question from a loan agent asking to explain what this mortgage bond phrase means in plain English. So here goes. Consumers only care about the rate quote. But for those interested, this is part of what’s going on behind the scenes.

AOT stands for “assignment of trade.”

An assignment of trade is a tri-party agreement between an Assignor (like a mortgage lender’s lock desk), an Assignee (an investor who the mortgage lender sells to like Wells or GMAC) and a broker/dealer (like Goldman Sachs or Cantor Fitzgerald).

Often a lender will sell a mortgage-backed security (MBS) to a dealer to hedge (protect) its interest rate risk. At some point in the future the dealer is expecting this security to be delivered to it, and the seller is obligated to deliver it unless it buys back the security (“pair it off”).

But a third option exists whereby the lender sends the loans to an assignee like Wells, and assigns the trade to them as well. At that point Wells is obligated to deliver a security to the dealer.

Put another way, after the MBS is sold to the dealer, when the loans are closed and ready to be delivered, the mortgage lender (assignor) sends the files to the investor (assignee) who then delivers the MBS to the broker/dealer, at which time the mortgage lender lock desk has fulfilled its delivery agreement while avoiding pair-off fees.

Avoiding expenses is the name of the game, whether it is the lender not paying the bid/ask spread to the dealer, or not paying the assignee for failing to deliver any loans.

In theory saving these expenses leads to better rate pricing to loan agents and their consumer clients.

To take this a little further, the lender is essentially investing in the servicing strip (sometimes there’s excess servicing too) while the lock desk is executing at TBA prices instead of the lender’s marked-up rate sheet. AOTs are generally more profitable when servicing released premiums are rich, which is not the case at the moment. That is why so many originators are setting up relationships with sub-servicers.