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   ARTICLE   |   From Scotsman Guide Residential Edition   |   August 2017

Originator’s Guide to Loan Pricing

Pierce the veil of the secondary market to find the best rates

r_2017-08_brown_spotDo you remember the “Hitchhiker’s Guide to the Galaxy”? At the core of the story — written long before smart phones and tablets — was an incredibly useful, incredibly simple hand-held electronic guide to the entire galaxy that held information contributed by the very aliens who experienced it every day. The cover even had a reassuring message for anyone overwhelmed by what was going on around them: “Don’t Panic.”

In honor of the book’s author, the late Douglas Adams, it occurs that originators can benefit from a glimpse into the seemingly mysterious, alien world of secondary marketing and capital markets from the perspective of an experienced secondary market hitchhiker.

Defining secondary

It can be hard to conceive how originators perceive the secondary marketing role. From the outside, it can look quite mysterious and esoteric, and some secondary market professionals legitimately bask in the complicated nuances of capital markets. The reality is that the secondary market is not that opaque — at least the basics aren’t.

Granted, there are many parts of the secondary marketing process that can make heads spin. A panel discussion at the 2017 MBA National Secondary Market Conference & Expo, for example, which explored strategies considered when an aggregator translates a security price into a mortgage price, became a bit over-whelming for many observers.

Although the theoretical and mathematical intricacies of this process are interesting to some, originators need not feel intimidated by the intricate details, and should be open to understanding basic secondary marketing concepts, so they can see how they fit into the entire mortgage process, thus making them better at their jobs.

At its core, secondary marketing generally focuses on four concepts:

  • How to price a loan to entice an interest rate lock commitment (“lock”);
  • How to hedge that lock;
  • How to find the best execution for that lock when it matures into a loan; and
  • How to report profitability and diagnose slippage for management.

It really is that simple. We don’t have the unlimited space of an electronic guide to the universe, so instead we’ll focus on pricing, which is the part of this process nearest and dearest to the hearts of originators.

Choosing investors

Before discussing pricing, however, it is important to understand why your company originates loans. It’s easy to understand why originators work so hard to close loans: Commissions are king. But why is the company interested in originating those loans?

If you work for a depository bank or credit union, the answer may be as simple as providing a benefit to customers or members. In those situations, secondary marketing is not as critical, because these institutions may have the luxury of putting loans into their portfolio. This strategy is limited by available capital and risk tolerance, however, and is not available to independent mortgage bankers.

Many originators just want to know they are getting the best possible prices they can take to the streets to close deals.

If your company doesn’t want to keep the loan on their books, then they must sell it. Choosing the right investors often depends on what kind of originator you are. If you are a retail lender in a small market with a solid net worth, you have the luxury of a range of investors. If you have a lower net worth and are focusing on a call-center strategy, perhaps a smaller niche of investors will better suit your company’s loan profile.

Essentially, each mortgage company must figure out where it will sell its loans. Their choice of investors ultimately boils down to a combination of relationships, pricing, operational capabilities and stature. The recipe for each organization is different, but this investor choice will affect the pricing available to you that you can then take to your borrowers.

Pricing

Let’s turn now to pricing structures. How does your secondary team derive the company’s pricing? Do they build in margins? Will that affect your profitability and ability to attract new clients? 

There are several strategies, from basic to sophisticated. Some companies base their pricing on best efforts, which means the originator will make “best efforts” to deliver the loan to the buyer (the investor). In this case, the lender’s secondary marketing team will look at the best-efforts pricing available from their investors, perform a calculation to add a margin to cover the company’s costs, and put that revised price on the street.

Many times, this price is labeled under the name of the ultimate investor. There also may be a margin included in the price, which is generally the best practice for lenders. Some lenders may be more transparent with their pricing and simply collect fixed fees instead of building in margins. Either way, a price is provided to originators, which they can then present to borrowers and close deals.

There are more advanced strategies for establishing pricing, of course. Some companies use “best execution” from all the pricing available to them, which just means they must sell the loans in such a way that maximizes the investor’s revenues.

The company’s secondary market team will still add a margin to cover its costs, but it can then embed that price in a company rate sheet under its name rather than under the investor’s name. This pricing may be available either alone or alongside investor rate sheets.

Even more complicated options occur when lenders abandon best-efforts pricing schemes altogether and base their rates on a mandatory pricing structure such as assignment of trade, direct trade or some other strategy. The bottom line is that it shouldn’t matter to you. If the pricing available to you is competitive, you will win deals.

•  •  •

From the perspective of a mortgage originator, mortgage pricing can seem like a black box that spits out a rate. Many originators just want to know they are getting the best possible prices they can take to the streets to close deals. This brief overview of pricing has attempted to show the constraints that secondary marketing teams face when presenting those prices.

Obviously, there are many more elements of the secondary market that can be explored in depth, including the lock process, renegotiations and extensions, pull-through, best-execution strategies, and bulk-bidding, but for now, remember: “Don’t panic.”


 


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