1. C. Scott Riffle – Senior Vice President
To TBA
or Not To TBA
C. Scott Riffle – Senior Vice President
April 5, 2013

2. Take a Full Body Cleanse!
Just say it, “Bonds are Dead!” (but don’t quote me)
Didn’t that feel good?
Sometimes admitting the truth is half the battle
Bonds NEVER worked that well…
Negative Arbitrage
Non-Origination Risk
Advancing of Cost of Issuance
GIC’s
Difficult Tax-Exempt Bond Program Restrictions
Market Risk Premiums for Local HFA’s
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3. Can I Compete in My Program Area?
Gauge the Competitive Environment
Is a State HFA lending in my Program Area?
Is a Local HFA lending in my Program Area?
Do Lenders in my jurisdiction have CRA/Subsidy programs operating?
Chase, Wells Fargo, etc.
Can the Local HFA compete or offer something unique?
Systems in Place
Create Lender Loyalty
Create Program Loyalty
Innovate
Do I Have a Servicer?
Assess Upfront Costs and DPA Advance Requirement
As much as $25,000 issuer counsel fee
Must have cash resources to Table Fund DPA
Estimate Loan Volume
Is my lending area large enough?
If YES, then TBA BABY!
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4. Background
Traditionally, most housing finance authorities (“HFAs”) have used the tax-exempt bond market to fund single family housing programs
Traditional bond market funding model broken (refer to Full Body Cleanse!)
As a result HFAs are looking for alternative ways to fund mortgages and successfully complete their missions
One program that has emerged uses the secondary mortgage market for funding
Names used to describe similar programs include: Market Rate Program, Daily Pricing Program, TBA Program, Turn Key Program
A TBA Program functions like a traditional mortgage program
TBA programs are not without risk
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5. Interest Rate Risk
In addition to a source of funding, mortgage revenue bond programs minimized interest rate risk for the HFA
If mortgage rates fell after the bonds were issued, the HFA could:
Lower issuer fee
Call bonds (non-origination call)
In either case, the HFA’s exposure to interest rates changes (interest rate risk) was minimal
Using the secondary mortgage market introduces the HFA to interest rate risk
Bonds issued (cost of funds)
Mortgage rate published with lenders
Lenders take reservations and loans proceed through lifecycle
Mortgage Revenue Bonds
Mortgage rate published with lenders (daily)
Lenders take reservations and loans proceed through lifecycle
Loans are pooled into MBS and sold into secondary market (cost of funds)
Market Rate Program
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6. Market Rate Program: Mechanics
How it works:
HFA (or partner) set rate daily
Loans are originated through participating lenders
HFA (or partner) may choose to hedge against a change in interest rates
Master Servicer purchases loans
Master Servicer pools loans and creates MBS
HFA (or partner) purchases MBS at agreed upon price
HFA (or partner) sells MBS in cash market
Must generate sufficient proceeds from the sale of the MBS to pay program costs
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7. Market Rate Program: Rate Setting
Setting The Mortgage Rate:
HFA (or partner) set rate daily (at least)
Rate set to ensure pooled loans (MBS) can be sold at a price sufficient to pay cost of program
DPA, Lender Compensation, HFA Fee, Partner Fee
Example:
Program costs equal 6 points
MBS needs to be sold at a price of at least 106 to purchase the loan and pay program costs
3.5% GNMA MBS could be sold for a price of 106
HFA (or partner) sets mortgage at 4% with plan to deliver into a 3.5% GNMA MBS and sell the MBS at a price of 106, covering program costs
Coupons on GNMA I securities are always 0.50% lower than the mortgage rate to cover GNMA fees (0.44%) and servicing fees (0.06%)
Actual rate setting can be more complicated because of servicing proceeds - GKB has pricing models which generate mortgage rates based on program costs and current MBS pricing
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8. Need to Hedge (TBA) Rates not static, HFA needs a hedge
Rates not static, HFA needs a hedge
As rates move, so do the MBS sale prices
Rates have the potential to move substantially between the time the loans are rate locked and the time the MBS are purchased from the Master Servicer and sold into the cash market
Depending on the length of the rate lock, this can be up to 120 days
This leaves the HFA open to potential losses
Example:
Same terms as previous example:
Program costs equal 6 points, 4% mortgage rate and 3.5% GNMA MBS
At time the loan is rate locked at 4%, the 3.5% GNMA MBS sale price is 106
By the time the MBS is purchased from the Master Servicer, rates have gone up and the MBS can only be sold for a price of 104
HFA would need to pay 2 points (106 minus 104) to make program whole
Purpose of hedge is to minimize any such losses
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9. TBA Market TBA Market TBA stands for To-Be-Announced
TBA Market
TBA stands for To-Be-Announced
Allows for sale and purchase of generic MBS at a future date
Settlement dates are typically the 21st of each month
MBS must have a set of defined characteristics:
MBS Type (GNMA I, GNMA II, FNMA, etc.)
Coupon
Loan Type (30-year Fixed)
Ability to sell generic MBS at defined prices
Lock in MBS sale price on date of rate lock
Ensures sufficient premium can be raised when selling the MBS to purchase the MBS and pay program costs
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10. Pull-Through Risk
Okay, now that the TBA (hedge) layer is built in we are all set, right? WRONG!
All loans that are rate locked don’t close:
Once loans are rate locked, they move through the loan pipeline
Not all loans that are locked close (fall-out)
What is the risk to the HFA?
The HFA (through the TBA trade) has already sold the MBS at 106 (previous example)
If the loan fails to close, the HFA will need to buy the MBS in the cash market
If rates have fallen, the cost of the MBS could be higher, let’s say 107
The HFA would then buy the MBS at 107 and sell it at 106 resulting in a one point loss
The TBA market offers more efficient ways to deal with fall-out but the net result is the same
This introduces “pull-through” risk:
When hedging, the HFA must correctly predict the percentage of loans that are rate locked that will actually close
If pull-through is not predicted correctly, the HFA could suffer substantial losses from over or under hedging
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11. Flow Chart
The diagram below illustrates the steps in a market rate program.
HFA/Partner Sets Mortgage Rate Daily
Lender Requests Rate Lock For A Specific Borrower
HFA/Partner Hedges Against a Change In Interest Rates By Selling TBAs
Does Loan
Close?
HFA/Partner Monitors Loan Progress From Lock to Close
Master Servicer Purchases Loan From Lender
Yes
Master Servicer Pools Loans and Creates GNMA MBS
HFA/Partner Purchase GNMA MBS from Master Servicer No
Adjust Hedges If “Pull-Through” Exceeds Expectations
Adjust Hedges If “Fall-Out” Is Lower Than Expectations
HFA/Partner Deliver MBS into TBA Hedge or Cash Market
Cash Market Program
TBA
Program
Legend
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12. HFA Shares Program Management
Managing A Market Rate Program:
Which One Is Right For You?
The diagram below describes execution strategies
for implementing a market rate program.
Is the HFA willing/able to take on economic risk? No
Yes
HFA Sponsorship Model
HFA utilizes a partner to take economic risks and simply collects a program fee.
Does the HFA want/need assistance in program management?
HFA Shares Program Management
HFA works with an entity to monitor the program/ pipeline and assist in hedging but retains 100% of the economic risk.
HFA Operates Program
HFA runs program on its own & accepts 100% of economic risk. Only needs broker/ dealer to execute TBA trades or cash market on its behalf.
Low Risk
More Risk
Most Risk
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13. TBA Program Summaries Page 13
Information gathered from Program Guidelines and/or websites of the specific Program Sponsors. For Discussion Purposes Only.
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14. Wrap Up
With the current interest rate environment, HFAs must find alternative sources of funds from mortgage revenue bonds to fund their single family housing programs
One option is to use the secondary mortgage market but there are a variety of considerations before HFAs enter this market
HFAs must tailor their own programs to fit their unique circumstances
Interest Rate Risk
Risk Tolerance
Staffing
Local Market Characteristics
Pull-Through Risk
Political Environment
Relationship with Lenders
Relationship with Servicer
HFA
Considerations
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15. Thank You! C. Scott Riffle, Senior Vice President 303-292-1600
Mr. Riffle has more than 22 years of experience providing investment banking and housing expertise to HFAs. Mr. Riffle is the lead banker for several TBA related engagements, including Pima County IDA, Tucson IDA, South Plains HFC and Nortex HFC. Mr. Riffle played a major role in the creation of the structure that won the NALHFA 2009 Single Family Excellence award for Jefferson Parish Finance Authority. He is also one of the firm’s experts in finding, negotiating and structuring the use of Community Reinvestment Act (“CRA”) dollars into housing bond and loan programs. The breadth of Mr. Riffle’s housing experience is further exemplified by the complex transaction he recently closed for the White Mountain Apache Housing Authority which resulted in $1.8 million in cash savings that funded housing construction and much needed job creation on the Fort Apache Reservation. Prior to joining the firm, Mr. Riffle served as a vice president with the Wall Street firm of Dillon Read & Co. where he served myriad municipal issuers in Colorado, Texas, Oklahoma and Louisiana. Mr. Riffle coaches junior baseball in his community and is a proud member of the Society of Mayflower Descendants.
The information contained herein and in our presentation is provided for informational purposes only. It is not intended as advice nor does it create an advisor/client relationship between GKB Mortgage Markets Inc. or George K. Baum & Company and any readers or recipients (to the extent such relationship does not already exist). Readers should consult with GKB Mortgage Markets Inc. and George K. Baum & Company or their own advisors to discuss how these matters relate to their individual circumstances. Reproduction in whole or in part is prohibited without the express written consent of GKB Mortgage Markets Inc. and George K. Baum & Company.
This report was prepared from data believed to be reliable but not guaranteed by us without further verification or investigation, and does not purport to be complete. It is not to be considered as an offer to sell or a solicitation of an offer to buy the securities of the entities covered by this report. Opinions expressed are subject to change without notice. George K. Baum & Company may act as a principal for its own account or as agent for another person, in connection with the sale or purchase of any security which is subject in this report.
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