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   ARTICLE   |   From Scotsman Guide Residential Edition   |   March 2015

Deal out Your Loans

Learn to play your best hand when selling on the secondary market

Deal out Your Loans

Lead generation, sales, compliance and customer service are all vital aspects of mortgage origination, but as any banker or broker knows, the origination business doesn’t end when a loan is closed. Selling loans on the secondary market is a central facet of the mortgage industry, and as such it’s a topic that deserves careful consideration, planning and management.

Secondary marketing, the process of capturing the cash on the sale of a company’s loans, can make or break a mortgage operation. There are many different ways to deliver products to the secondary market, however, so how each company deals their loans out to the secondary market is a matter of style and often requires as much art and finesse as generating the loans in the first place.

The individualization of the secondary market allows mortgage companies to have unique characteristics — and unique ways of turning profits. What does your company need to know to ensure you’re dealing with the secondary market in the most profitable way possible? Let’s try to put some sense into dealing with the secondary market as it exists today.

Breaking it down

When you’re about to lock in a loan with a borrower, your secondary marketing — whether it consists of an entire department or an individual loan officer — prices that loan for the final investor, ensuring the funds you receive are greater than the funds you shelled out at the closing table. This process may sound simple enough, but it can be deceptively complex. To understand why, you must take a closer look at where these loans end up.

Since the crash of 2008, nearly all loans that banks originate end up in a Fannie Mae, Freddie Mac or Ginnie Mae mortgage-backed security (MBS). No matter how you sell a loan or which correspondent lender you sell to, the base pricing for that loan begins with the MBS price. This remains true every day that the MBS market is open for trading. Even if you sell directly to the government-sponsored enterprises (GSEs), the price you receive is still a function of MBS pricing.

So, if all of this starts with the MBS market, why is pricing so different between investors? The answer to that question lies in the valuation of other variables that investors price into a loan. At the end of the day, investors are like originators: They’re buying loans to make money.

Investors determine prices based on complex formulas established by their accountants, mathematicians and tax lawyers. Even so, by looking at the MBS market, mortgage banks’ intent on secondary marketing can cut through all the noise of pricing and come up with accurate values for their loans. Several components should be considered in this regard:

  1. Current price for an MBS, plus or minus the value of any buy-up or buy-down;
  2. Service release premium (SRP) paid;
  3. Loan level price adjustments (LLPAs);
  4. Required profitability

After building in an investor’s profit margin, all of these factors equate to what you believe that investor is willing to pay for your loans. It’s up to your organization’s secondary marketing wing to understand the complexities inherent to these transactions and then determine the optimal sale price to meet your company’s revenue objectives.

Another key aspect of secondary marketing is determining how loans are actually delivered to the secondary market, and what revenue your organization can expect for each delivery method. These methods can be broken into three broad categories.

1. Best-efforts approach

Many — if not most — mortgage originators subscribe to third-party pricing engines. These tools can give your company a way to compare multiple investors’ best-efforts pricing on every loan. In other words, you get the price, set your profit and lock in with the investor of your choice. This  delivery method is commonly perceived as safe and easily managed at the loan level.

The downside, however, is that revenue for best-efforts pricing ranges from 20 basis points to 50 basis points fewer per loan than other delivery methods. Obviously, this can significantly cut into your profit margins.

Take 30 basis points, for instance, and multiply that by your total year-to-date production. Chances are this number represents a major portion of your organization’s net income — a portion that could potentially be lost when using this delivery method.

2. Mandatory delivery

The correspondent lending community has seen some changes since 2008, but despite that a couple of conduits remain to the mandatory delivery arena. Many of these investors are the same ones that offer best-efforts pricing. If you elect to pursue mandatory delivery, be prepared to:

  • Manage your price and fallout risk internally. Be prepared to hedge your sales on the secondary market. An entire book could be written on this topic but, for our purposes, understand that to hedge in this respect is to take an offsetting position in a similar market or instrument to reduce your risk of loss. Instead of letting the investor/conduit hedge your sales for you on a best-efforts delivery, your company must take these measures itself.
  • Look at the risk/reward ratio. Hedging your sales also means that you must fight for the opportunity to achieve better pricing and greater flexibility in the management of your revenue stream.
  • Strive to make as much as you can on every loan. Naturally, you can achieve this via a different delivery channel, as well.
  • Focus your delivery on one or two investors. Your company may find greater efficiency by delivering to a limited number of investor partners.

Mandatory delivery may sound risky, but with proper guidance and knowledge, it can greatly improve your profitability.

3. Direct sale

Of course, if you can gain approval, you can always sell loans directly to the GSEs. Nonetheless, some mortgage banks with the ability to conduct direct sales still sell to conduit investors. This approach boils down to the value of a loan’s servicing rights.

In other words, you can get your cash today, or you can get it over a period of time. There are ramifications to building a servicing portfolio that goes beyond the immediate need for cash today, so your company should be well aware of these ramifications.

Some programs allow you to sell to the agencies and sell packages of servicing rights on separate transactions. This delivery option gives you the ability to manage your business around its own operation instead of relying on the ebb and flow of investors. This approach is not for everyone, but if you have the approval to sell in this manner, it’s certainly worth exploring.

•  •  •

Believe it or not, secondary marketing may be a summation of everything you already love about the mortgage industry: The diversification of entities, multiple ways of delivering a product, and the debate of hedging your own sales versus letting someone else do it for you are just a few of the central components of secondary marketing.

Whichever method you choose, this facet of the mortgage business is all about servicing your client base and doing it profitably. Ultimately, disciplined navigation of secondary marketing activities is the path to managing your budget and ensuring your organization’s financial success.

Careful, strategic administration of this aspect of the business can lead your company to growth as well as long-term stability. 


 


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