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Quick thread on the economics/costs of issuing RMBS. I have done a few threads looking at the investor point-of-view, but what if you're a firm with $300M+ of mortgages on a balance sheet (either your own or a bank warehouse)? Can you turn a profit selling RMBS? Let's find out!
First let's see what kind of proceeds we can generate from selling the bonds. The table below was created for a deal backed by $328,950,324 in 30-year jumbo mortgage principal with a weighted average rate of 4.386% (4.106% net of servicing costs). Let's walk through it:
On the left we have the 9 classes of bonds we want to issue and the mortgage principal that will be assigned to each class. 3 of these are senior and 6 are subordinated (I redacted 2 additional classes which were being proposed as an alternative structure, for clarity)
In the 3 senior tranches, we are selling 85% of the pool as AAA-rated super-senior notes and 8.5% as AAA-rated senior mezzanine notes. We are also selling a senior interest-only tranche, which is a trick we can do since the 3.5% coupon on the senior notes is lower than 4.106%
Okay, now to the junior tranches. We are only selling the top 2 of these (the subordinate AA-rated and A-rated for a total of 3.4% of the pool principal). The remaining 4 tranches will stay on our balance sheet as a first-loss cushion for the bondholders.
Now for the pricing! RMBS notes are usually priced as a spread to benchmark, which is either Fannie/Freddie MBS rates (called TBA) or swap rates. Here, we modelled 140 to 165bps of spread to the relevant benchmarks for the bond classes we were selling.
Okay, so summing up the totals, we generated about $331.4M from the sale of bonds and kept only $10.2M of the original $329M pool on our balance sheet. Not bad! But wait, we also had costs. Let's go over those as well!
Overall, all this engineering is costing us about 2 million bucks, with the biggest items being the paying the investment bank for underwriting the deal (~800k), lawyers (~500k), and the rating agencies (~350k), plus a number of miscellaneous fees (~300k total)
Once we substract this from the $331M in cash we realized, we are left with a meager profit margin of 0.15% or a mere $480k (less than the lawyers got, YIKES!) Note that I am not including the $10.2M in bonds we still hold since those must be held to maturity (and may default)
Okay, so why would anyone do this sort of deal if the "arbitrage" margins are almost vanishingly thin? The answer here is servicing fees. Remember how our mortgages had 4.386% gross coupon but only 4.106% after fees? That difference of 28bps is collected by us as the servicer.
While 28bps may not seem like a lot, on $329M that is $921k a year! And by doing this transaction, we are freeing up space on the balance sheet to make more loans and repeat the process again. Very cool!
In conclusion, issuing RMBS is a thin-margin market. Below ~$300M you are barely breaking even. The benefit is offloading assets to access higher margin revenue like servicing. In the deal itself, bankers, lawyers, & rating agencies usually end up better off than the issuer.
As always, thanks for reading if you made it all the way to the end and I hope this helps clear up some questions I've been getting on the economics of doing these sort of transactions!
