Subprime Mortgage Pricing On The Secondary Market
Question: How are subprime loans priced on the secondary market?
Example: lender gives subprime mortgage of $250,000. 30yr-fixed @ 7.49% to a borrower with credit score of 620.
What determines the price the lender will get for this loan on the secondary market?
Technically we don't do "subprime" anymore (or at least we don't call it that) but I don't think that's your point.
There's a fairly active/liquid residential whole loan market, so in the simplest terms it's priced by discounting the cashflows at whatever the observed market yield is for that type of collateral.
To determine what you think is the "appropriate" yield, you'd want to have some sort of view on the prepayment speed of the collateral (timing of cashflows) as well as the likelihood of default/loss given default on the collateral (amount of cashflows) to inform what you're expected yield/spread is, which you can then comp to other asset classes. This type of "fundamental"-ish analysis is more relevant to off-the-run or otherwise idiosyncratic collateral (think RPL/NPLs) than liquid new production loans.
For more generic stuff (e.g. Non-QM), you can also price to securitization arb by working up a hypothetical capital structure using expected rating agency loss coverage levels (using collateral data), inputting market spreads/yields on the sold classes (~BB and above) and pricing the subs/residuals to a target IRR/levered return (under the assumption that you, the whole loan buyer, are going to own the subs/resids).
Generally speaking though, if you are involved in this market, you will sort of just have a sense of where things are pricing, so will not need to go through the mechanics of the above exercises every/all the time. I would say that Non-QM (closet thing to modern day "subprime") is currently pricing to ~low 300s spread over Treasuries at the moment, which translates to 6.0-6.4% yield depending on the exact collateral/pricing assumptions.
Thank you for taking the time to share this through walk through. I am not in the industry, so I needed a week to fully digest the dynamics of all this.
I have a few more questions:
No problem, it's certainly not the easiest/most intuitive stuff to wrap your head around.
In this case, when I'm referring to collateral, I'm referring to the mortgages themselves, not the underlying properties. It's admittedly somewhat sloppy wording given the ambiguity (your confusion is not unreasonable) but I guess we typically refer to it that way because the loans usually collateralize a deal/securitization.
On your second question, the right to foreclose on the property travels with the lien/note (otherwise a mortgage would be much more difficult to sell!). That being said, it is the servicer (which is often not the same entity as the owner of the mortgage or even the same one that originated it) that executes foreclosure proceedings. How much leeway the servicer has depends on the context, but it's ultimately up to the owner of the underlying mortgage, since they generally have the right to choose which company services the loans and under what terms.
In some cases, the loan could be owned by an active asset manager that will dictate servicing/loss mitigation policy to the servicer. In the case of a securitization, the "owner" of the loan is technically just a legal trust (which itself has issued notes to investors). In those cases, there is a pooling and servicing agreement that outlines the servicer's rights and responsibilities to act on behalf of the noteholders when deciding how to handle delinquent loans, modifications, foreclosures, etc.
Thanks again for another thorough explanation, this really helped me.
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