The following is an excerpt from Appendix One of Chapter 2 in Volume III of The Mortgage Professional's Handbook:
WAYS TO LOSE MONEY IN SECONDARY MARKETING
by Dean Brown, CEO, Mortgage Capital Management, Inc.
“Great companies are similar in a lot of ways; poor companies are unique in their own way.”
The difference between a highly profitable mortgage lender and a mediocre one sometimes comes down to the methods, tools, and experience deployed to minimize risk and optimize execution. There are many ways to run your Secondary Marketing / Capital Markets operation and knowing the difference between the most and least effective means is a key differentiator.
Hedging
1. Treat the market pipeline risk on loans as TBA trades and forget about servicing value and changes to fallout and convexity.
2. Assume that a 10-basis point move in the market is as likely as 100-basis point move in your model’s shock analysis.
3. Don’t use options when a pipeline source, lock type, or renegotiation policy dictates their use as necessary.
4. In a volatile market mismatch the timing of TBA Pair-offs with loan sales.
5. Assume that Stips on securitizations will remain constant.
6. Assume that Correspondent and Agency LLPA’s will remain constant.
7. Don’t keep pipeline data clean – let users abuse the tracking system.
8. Don’t track Concessions and Renegotiations.
9. Calculate actual fallout incorrectly.
10. Assume locks that fallout after only 5 days are equal to fallout from loans that fallout after 60 days.
11. Let loans floating in the pipeline lock in with prior day pricing after the market has opened the next day.
12. Don’t back up your loan pipeline or secondary marketing data.
13. Cross hedge your conforming 30 yr. pipeline with mismatched TBA coupons and/or products.
14. Hedge your pipeline with 10-year treasury futures or 5yr swaps because “the roll is lower”.
15. Expect closing rate characteristics of a pipeline will never change.
16. Don’t reconcile Pipeline Risk Positions between reports and/or intra-day.
17. Assume that you can always add more trading capacity if and when your pipeline coverage requirements, or pipeline grows.
18. Never call your broker/dealer and trade exclusively online. The screens are always right.
19. Don’t track your margin requirements on TBA dealer accounts.
20. Don’t track Correspondent and Agency pricing spreads.
21. Sell loans on days when Correspondent and/or Agency spreads are low.
22. Assume that Agency and Correspondent spreads to TBA are fixed.
23. Buy Options when Implied Volatility is too high relative to the actual level.
24. When buying options for pipeline hedge purposes only purchase 10- yr. Treasury Puts, assuming the basis doesn’t matter.
25. Use Treasury options without knowing how to calculate the cheapest to deliver.
26. Don’t independently verify and confirm trades done in secondary marketing.
27. Don’t confirm the details of loan sales with correspondents – neither party ever makes a mistake.
28. Allow for a disproportionate number of trades to be concentrated with one dealer or investor because they are too big to fail.
29. Forget to pair off trades after selling inventory late in the day.
30. Refuse to post margin on a trading account – there are plenty of dealers with whom you can trade.
31. Don’t reconcile your trading accounts for mark to market accuracy, trading capacity, or settlement details.
32. Price Float-down locks and credit back the upfront fee without adjusting the Caps and float down pricing.
33. Hedge Long-term float-down locks by selling TBA only because delta hedging exclusively works…
34. Sell builders aggressively priced forward commitments without the ability to securitize the product.
35. Sell builder’s forward commitments expecting less than the dollar amount sold to be delivered.
36. Price all forward builder commitments the same based on market conditions and the term of the deal.
37. Grow company originations beyond the capability to process, fund and hedge the production.
38. Cross hedge risk positions without the need to do so, e.g., sell FNMA 15 yr. 3.5’s to hedge GNMAII 30 yr. 3.0’s.
39. Go long or short within product types or delivery months without the need to do so.
40. Assume you won’t get more than 5% of your loans in as High Balance.
41. Always rely solely on your market data service provider to give you an accurate picture of the current market and its movements. Rolls and bid-ask spreads never change and are the same with each dealer.
42. Assume that if you sell loans on a best-efforts basis your risk is fully transferred to the investor.
43. Bet which way spreads between mortgage coupons/products will move – if you are flat overall nobody will notice.
44. Use another firm’s MBS prepayment model designed and tuned for a long-term holding period to set hedge ratios on a 30–60-day pipeline.
45. Allow your Hedge Advisory Firm to get paid by Broker Dealers and/or Correspondent Investors.
46. Allow your Hedge Advisory Firm to sell your borrower’s loan information to a third party.
Pricing
47. Let borrowers change loan programs at will without regard to pricing or execution.
48. Don’t update pricing when the market improves or sells off.
49. Ignore loan changes that impact pricing, especially ones that have disparate impacts to LLPA’s.
50. Price loans on a mandatory basis and deliver them on a best-efforts basis.
51. Price loans on a best execution basis to deliveries that are not available when loans close.
52. Switch loan processing or pricing engine systems without assessing the impact to secondary marketing data files and positions.
53. When losing money on the sale of loans into the secondary market – improve pricing so you can make it up with volume.
54. Rely on pricing surveys to set your rate sheet pricing – competitors always post accurate pricing for you.
55. Assume that the Spread between Mandatory and Best-Efforts pricing is constant.
56. Price loans using your best execution and expect the same profitability level when loans must be sold to a different investor due to documentation, LLPA, or underwriting criteria changes.
57. Allow loans to renegotiate to current market at will without pricing and hedging them with the use of options.
58. Don’t centralize your pricing, lock, and trading desks.
Investors
59. Close and sell loans to investors that do not meet investor requirements and expectations.
60. Refuse to negotiate with investors on problem loans or just accept what an investor states in their buyback request.
61. Don’t negotiate pricing with investors – they always give you their best price.
62. Expect investors to renegotiate when rates fall.
63. Expect investors to extend locks without a cost when it takes longer than expected to close a loan.
64. Let investor-suspended loans linger.
65. Don’t allow enough time for warehouse bank to forward note to investor.
66. Ignore reasons a new investor’s loans get suspended.
67. Only sell loans to the best priced investor.
68. Don’t follow-up with your investor’s request on post-closing docs.
69. Don’t keep a trade blotter to track trades with dealers and investors.
70. Don’t reconcile Trade Confirmations.
71. Don’t reconcile purchase advices – investor’s never make a mistake.
72. Only use one investor for each product.
73. Expect investors to rationally price every rate and delivery period available. Assume that if they were the best in one spot, they will be for all.
74. Use bid tapes that provide all potential investors with Customer Identifiable Information for each loan even though they do not win the bid.
Operations
75. Set up Secondary Marketing as a profit center and pay manager to exceed profitability targets.
76. Compensate secondary marketing manager solely on Gain on Sale profitability.
77. Pressure secondary marketing manager to make a certain amount of profit above what’s priced in Gain on Sale.
78. Don’t measure the effectiveness of the secondary marketing department.
79. Don’t have a concrete policy for managing risk pipeline positions - let manager “bet” the market.
80. Make secondary marketing staff work beyond their capacity or area of expertise.
81. Don’t clearly state your lock extension policy in your policy manual.
82. Allow originators the ability to broker locked-in loans for better pricing.
83. Allow production staff the ability to lock hedged loans directly with investors.
84. Allow the risk position manager to sleep in – the market is always improving.
85. Let the shipping manager decide when loans are to be delivered to an investor.
86. Let the loan origination manager decide what pricing levels should be.
87. Allow loan officers to back date locks.
88. Allow loan officers to manage loan data.
89. Don’t cross train secondary marketing staff.
90. Allow loans that have been “In Process” to lock with the previous days pricing after the economic data for the day has been released.
91. Hide trading, pricing, delivery and/or other mistakes nobody will notice.
92. Don’t fully commit to changing the way you do business when moving from a best-efforts execution strategy to a hedged mandatory delivery strategy.
93. Outsource the lock desk, pricing, trading, and risk management functions of secondary marketing to your Hedge Advisory Firm without oversight and management.
94. Don’t calculate what each channel of business, branch and loan officer brings to the table from a total contribution analysis basis.
95. Don’t track P&L expectations from loan sales and pair-offs because accounting will always get the number right eventually.
Locks
96. Extend locks well beyond their lock periods – take too much time to close loans without making pricing changes.
97. Leave locked loans that don’t move through the normal processing stages to stagnate i.e., leave them in the risk position until after they expire.
98. Let Loans locked in a “No Application” status to be in the pipeline for the entire lock period.
99. Allow the funding department to close loans on locks that have expired or don’t match what has been locked.
100. Don’t check the accuracy of your pricing engine lock system because you don’t expect things to change once programmed.
101. Delete locks that don’t close in your loan tracking system so fallout numbers are incorrect.
102. Commit locked loans to mandatory trades in excess of the amount expected to close - you can easily substitute them from new production.
103. Don’t review the profit margins on newly locked loans to verify pricing and potential delivery issues.
104. Price Long-term locks the same way you would short term locks.
105. Hedge float down locks and builder commitments the same or the same as regular locks.
106. Provide borrowers with long-term locks without knowing what the closing percentages will be in the event rates drop.
107. Allow loans that have no chance of showing up with a 1003 to be locked.
Miscellaneous
108. Create duplicate loans in your loan tracking system without regard to the impact to your fallout calculations.
109. Rely on just one warehouse lender.
110. Jump on the band wagon and create a loan program for everything that could possibly be available.
111. Don’t explore alternative sale executions because bulk sales to investors “XYZ” have always been your best execution.
112. When selling a servicing portfolio expect that its value will be same 6 months to a year from now.
113. Create new loan programs before production, processing, underwriting, compliance; IT, funding, and shipping are ready. Boats are best built-in open water….
114. Don’t audit note inventory to loans sold to the Agencies.
115. Don’t pay attention to cash flow of loans sold versus pair-offs because your company has plenty of cash to maintain margin accounts.
116. Assume that your Agency guarantee fees, buyups and buydowns will not change.
117. Count extensions as fallout when calculating your pull through percentages.
118. Assume that loans still in processing stages of No application, In process, or Submitted will close at the same rate after exceeding your company’s normal timeline in that status, but before expiration of the lock.
119. Assume all wholesale brokers are the same from all perspectives
120. Assume all correspondents are the same from all perspectives.
121. Assume all branches and loan officers are the same from all perspectives.
While the list above provides many ways to “Lose Money in Secondary Marketing” we are sure there are many more that have not been listed. The purpose of the list is to not make a list, but to give mortgage banking professionals a guideline for referral. Also, for every one way to mess up there probably are a hundred things that need to be done correctly in order to prosper.
Read the rest of this chapter in The Mortgage Professional's Handbook!
Dean Brown is the founder and CEO of Mortgage Capital Management. Since 1994, MCM has effectively helped mortgage bankers maximize profitability, decrease earnings volatility, and powerfully manage their risks. Dean is one of the longest-running secondary-marketing service providers in the industry. Since 1984, he has held a variety of positions in the industry, including Senior Vice President of Secondary Marketing, First Interstate Bank, Vice President of Secondary Marketing, The Hammond Company, and Assistant Vice President of Asset and Liability Management, Security Pacific Bank.
Dean’s extensive knowledge and experience in the industry inspired the conceptualization of a unique bundle of offerings including consulting, pipeline, interest rate-risk management services and tools.
Dean has a Bachelor of Arts degree from Claremont McKenna College with an MBA from the University of San Diego. He has held a California real estate broker’s license since 1991 and is an active member of the Mortgage Bankers Association.