As a follow-up to Rob Chrisman’s April 9th post –

When technology improves, it takes a long time to bring everyone along. You will always have those on the bleeding edge as well as steadfast luddites. The vast majority will be somewhere between those extremes.

The reality is that most of us, to varying degrees, are resistant to or wary of change. We keep doing things the way we know how until we get to a point where either we have no choice or we finally have that epiphany that the new way is worth the pain of switching.

When I started traveling for business, I would print out maps for each location on my itinerary and carry a stack of paper with me. Over time, with smart phones and navigation apps, such a practice is obsolete. You can still accomplish the goal by printing out maps but why would you not avail yourself of the more efficient process.

We hear comments from time to time about whether real-time pricing is necessary for either the hedging or the best execution and loan allocation processes. The reality is that it is not necessary. Just like the map print outs mentioned above, you certainly can accomplish the goal of managing risk and selling loans without real-time data.

Heck, the secondary markets existed, and functioned well, years before there was even reasonable market transparency. A good friend of mine told me a story once about a secondary marketing conference during the Black Friday event of the late 1980’s where once news of the dramatic market movement of that day made its way to the ski resort where they were no doubt deliberating on some serious mortgage issues, everyone went scrambling to the bank of pay phones to get in touch with someone who could figure out their position and adjust their coverage. Did people lose money on that day? No doubt. However, they all were playing by the same rules and were under the same technological constraints.

The good news is that technology and market transparency both have improved significantly since that time. Those improvements have reduced greatly the nasty consequences that result from such technological and transparency deficiencies. And we will continue to see even more improvements which, in turn, will further minimize market inefficiencies and their consequent arbitrage opportunities.

The point is that if a technological innovation is available and that innovation will allow you to have more current information at the point of decision, why not take advantage of it? If real-time data is not necessary, then the question becomes how stale is too stale. Is it ok if your eligibility information is 24 hours old? 1 week old? More? How about pricing data? Is data from one hour ago stale? One day ago? Greater?

So I ask you, if real-time data is available to you when you are making a decision to adjust your position or to commit a certain loan or group of loans, why wouldn’t you use it?

Join the discussion here.

Don Brown
Managing Director, Secondary Services
Optimal Blue, LLC
(303) 483-2190

Managing pipeline risk can be relatively routine… until inevitable market volatility wreaks havoc on your careful planning. While declining markets bring their own set of challenges, namely lower volumes and excess operational capacity, it is the periods of rapid market improvement that tend to cause the most acute issues.

The cloak of increasing regulatory oversight has decreased the impact of low grade volatility on pipeline management. Loan officer compensation rules have all but eliminated the loan officer’s incentive to suggest that borrowers adjust to incremental rate changes during the term of the rate lock commitment, and swelling transaction friction resulting from regulatory reform have made purchase locks stickier.

Regardless, significant and sudden market improvements will continue to provoke requests for rate renegotiations. I call it the “CNN Effect.” A market change has to be big enough that borrowers take note of it through their various media sources and, as a result, are compelled to seek a rate renegotiation.

Handling renegotiation requests effectively is key to a successful secondary marketing strategy. To be effective, like winning the Super Bowl, you must have a strategy going into the game so you can follow the playbook when different game situations present themselves.

Your rate renegotiation policy should be in place before the requests even come through the door. The company strategy must be clear. Those on the secondary desk must have a strategy for dealing with such requests, and sales personnel must know the company stance.

Internal lock desk guidance must focus on balancing organizational profitability with the needs of the business to maintain customer relationships. Loan officers should understand the company’s tolerance for keeping production through renegotiations. The policies deployed to each of these teams need not be identical, however, they must work in concert to achieve the short and long term goals of the organization.

As an example, the loan officer, or external, policy may include details similar to the following:

• All rate renegotiations must be borrower initiated;
• A renegotiation may allow for an improvement in rate, but not an improvement in price;
• Once a lock is renegotiated, the lock becomes mandatory, and failure to fund will result in applicable pair-off fees based on market movement (if locked with an investor); and
• The expiration date does not change upon renegotiation. Most policies require the renegotiation to take place within 15 days of expiration.

You also may consider only renegotiating locks that are past a certain stage in the origination process and limiting renegotiations to a “one bite at the apple.”

These rules are designed to discourage indiscriminant renegotiation requests and make sure that once a concession is given, the revenue from that loan, while diminished from what was expected originally, is known.

The policy for your lock desk or secondary team needs to be more strategic and tactical. Clearly it must involve enforcing the foregoing principles. However, the decision as to whether or not to grant a renegotiation request comes down to balancing your relationship with the borrower versus your profitability.

The spirit of the rate renegotiation is to offer a lower rate to a locked borrower when that borrower threatens to take their business elsewhere. Consequently, it is not sound policy to completely preempt all renegotiations. This would needlessly erode pipeline gains.

The question then becomes, how much am I making with this loan. To calculate this, you need to look at the profit in the loan at the renegotiated rate and then balance that against an estimated gain/loss from the hedge. Because there is no one-to-one relationship between any given loan and any given hedge position, the hedge gain/loss must be estimated by looking at the change in price for the TBA with the most relevant coupon and settlement date.

You also must take into account the pull-through percentage, as well as adjustments to that percentage. If you have structured your pull-through strategy using market based adjustments, then this may have offset some of the built in losses in an improving market.

In a rapidly improving market, you will have gains in the loans offset by losses in the hedge. As you give away those gains in a renegotiation, you change that balance. If you can find a way to keep the loan, you will preserve some of the gains. That said, you want to minimize what you give away.

Many companies will set a threshold of movement necessary before they will entertain a request for renegotiation. Additionally, you can offer the borrower current market but .25% in rate. While the borrower does have the option of walking away, given the transactional friction mentioned above, such an offer is likely to preserve a portion of those gains.

It is critical to develop a methodology for measuring the impacts of renegotiations on your pipeline profitability. This is difficult but critical for allocating profitability so that you can make operational adjustments necessary to maximize profitability.

Finally, the picture is not as bleak as it may sound. Often, in times of a sudden rally, another company’s fallout becomes your new production. Thus, while your profitability may be diminished on loans that you renegotiate, you gain new sales which bolster revenue.

Give us a call to talk about how we can help you design your rate renegotiation strategy to maximize your secondary marketing success, or join the discussion here.

Don Brown
Managing Director, Secondary Services
Optimal Blue, LLC
(303) 483-2190

A frequent topic of discussion we have with our clients concerns how they create the pricing they put out to the street. This is most common when lenders make the transition from best efforts to mandatory but also arises as their secondary marketing outlets evolve from one where they are exclusively focused on aggregators to strategies involving the GSEs, co-issue investors and retaining servicing assets.

In a best efforts world, lenders typically are pricing off of the aggregators to whom they sell. The originator could have multiple products and the loan officer can choose the investor. This can, and should, change as lenders move to selling mandatory and beyond.

Simply put, to measure secondary marketing performance efficiently, reliably, and most of all, accurately, lenders should use mandatory pricing as a basis for the pricing they put out to their originators. In addition, developing a single guideline and pricing structure for each product is paramount to success in hedging. The pricing and eligibility should be based on current execution options available to the investor. The secondary markets group then makes a decision on where the loan will be sold. This is the best pricing methodology for optimizing opportunities in selling mandatory.

Maintaining a pricing strategy based on best efforts pricing methodologies after you start selling mandatory can cause a number of issues.

First, once a lender has made the transition to mandatory deliveries, they typically no longer are selling the majority of their production to a best efforts execution. Thus, using such an execution as the basis for your pricing essentially is arbitrary. However, using the actual execution you intend to employ, or a blend of such executions, allows a lender to better measure performance throughout the hedging process. Additionally, it gives lenders more direct and deliberate control over their Loan Officer level pricing.

Second, while using a best efforts price as the base for your pricing may be useful for justifying the existence of a hedging program, it will cause problems tracking results once you are selling mandatory. This is because the best efforts mandatory spread fluctuates over time and this fluctuation obscures hedge performance. If you are attempting to measure your hedge performance accurately, you must eliminate as many of the extraneous factors as possible so that you can focus on the factors that actually are affecting hedge performance.

Third, by using best efforts pricing, the lender will have less control over pricing. Their pricing is directly linked to an aggregator getting in and out of the market. When pricing to the best mandatory execution, more spread is available for the originator to manage production.

Finally, it is the final step in transferring control of the decision of where to sell loans from the LO’s to the capital markets team. By switching to mandatory pricing with one guideline per product, the capital markets team will select the best execution when the loan is funded. This enables the firm to make better decisions on who to sell to and maximize profits and operational efficiencies.

When assessing hedge performance, it is more useful and relevant to compare gains assumed at the time of lock plus pre-determined profit margin less hedge costs against the gains actually realized upon the sale of the loan. Many firms price to best mandatory execution at the time and set the secondary markets gains to 0. This ensures that the maximum margin available is used to manage production. This also focuses the secondary marketing department on their primary goal of maintaining the margin set by the lender and maximizing secondary marketing revenue. In this way, when the loan is sold, the hedge performance easily can be determined using hedge firm analytical software.

Jim Glennon
Director of Trade Operations
Optimal Blue, LLC

This forum is designed to be engaging, informative, provocative, inquisitive and, hopefully, insightful.

It is a place where we will post our thoughts on best secondary marketing practices, capital markets developments, as well as commentary on industry news and perhaps, some random thoughts that will facilitate conversation and progress.

It is also a place where we hope you will contribute your thoughts, insights and reactions for all of us, either at Optimal Blue or in the capital markets community, to learn. We hope to provoke productive dialogue amongst our colleagues nationwide!

Basically, this is a place where secondary marketing and capital markets professionals can share ideas on technology, trading stratagems, market developments, product innovations and operational tactics.

We are in the midst of a pivotal time. The regulatory environment is here to stay but the results of the oversight and enforcement continue to evolve. Technology also is changing in reaction to the regulatory environment, the changing socio-economic and age demographics, and increasing availability of sophisticated technical capabilities and strategies.

We will publish at least weekly. We also aspire to invite guest contributors to raise issues that are on the minds of the industry.

Optimal Blue also encourages an open dialogue about industry issues, specifically through the expert panel discussions we convene at our annual client conference. There is no reason this dialogue has to be limited to once a year and this forum will provide a platform to continue that discussion throughout the year.

We begin this with a short article on pricing strategy. While this article originally was designed for those making the transition from best efforts to mandatory commitments, the principals it highlights apply to a much broader audience. We find that many of our clients need advice in formulating their strategy for deriving the price they put out to the street. In addition, there are opportunities to combine the power of our secondary technology to create a more dynamic pricing strategy in the pricing engine technology. Jim Glennon, our Director of Trade Operations, takes a straightforward approach as he explains the best practices that we have observed and recommended over the years.

We invite you to join this group and become a regular reader, if not contributor, so that we can collectively improve our understanding and execution of the mortgage origination process.

Join the discussion here. We look forward to the dialogue.

Don Brown
Managing Director, Secondary Services
Optimal Blue, LLC
(303) 483-2190