Pipeline Management in a Changing Mortgage Banking Landscape

By: Rob Chrisman •

[I am away from the computer, and cannot respond to e-mails until 9/10. In my place are daily commentaries from a series of very knowledgeable mortgage industry people with different backgrounds, and they have been given very little direction about what to write about - the latest is below. Our views may or may not coincide, but I thank them for their time in volunteering and helping out.]  

Today's contribution comes from...

Don Brown
Co-President
Secondary Interactive
dbrown(at)secondaryinteractive.com

GAINING PERSPECTIVE

In business, as with any other walk in life, making the right decision often is the result of having the right information at the right time. This is easily said but harder to do.

I am reminded of the story that Steven Covey tells about shifting paradigms based on new information. He was traveling in a subway, and observed a man get in with his two sons.  The sons proceeded to run all over the car generally causing havoc and bothering the people. This continued to the point where he finally got irritated enough to ask the father why he doesn't do something to control his kids. The father replies, "We just got back from the hospital where their mother died. I don't know how to handle it and I guess they don't either." Suddenly the perspective of the situation changed.

When managing a mortgage pipeline, there are multiple factors that affect its value every day. The easiest to grasp is day-to-day market movement.  However, just knowing that will not give you the complete story regarding how the value of your pipeline may have changed.  Like Mr. Covey in the parable, if you only know part of the information, you may very well make the wrong decision. Unlike Mr. Covey's situation, making the wrong decision regarding your pipeline could cost you money.

Primarily, it is important to understand the type of information that you need to know to make the best decision.  Then it is critical to gather that information in the relative time horizon.

In focusing on what information you need to know, let's look at a hypothetical scenario involving a decision to set coverage. Imagine a static $40 million pipeline with a mark to market ("MTM") of 50 bps. That MTM is comprised of a cumulative 100bp gain in the uncommitted loans and a 50bp loss in the open MBS positions. 

Over the course of the next day, the market moves a quarter of a point but the MTM deteriorates to 40 basis points. The initial conclusion could be that something changed in the hedge to make it inefficient and, as a result, I must either blame my hedge advisor or my secondary marketing company.

Upon further review, however, that may not be close to the right conclusion.   In reality, there may be several factors causing this problem. Causes could include status changes to the loans in the pipeline or the pricing to those loans. Perhaps the characteristics of the loan changed resulting in changes to the applicable eligibility or loan level adjusters.  Or, maybe there were changes to the TBAs or investor commitments that make up the trade side of the MTM.  Without knowing this information it is difficult, if not impossible, to be sure why your MTM moved.

Understanding this information historically has been difficult and takes considerable research.  Having this information at your fingertips, on demand, is essential to ensuring that you have the best information, at the right time, to make the pipeline and loan decisions that are critical to your profitability.

The opportunity now exists to have all this information at your fingertips.  More importantly it is also possible to know, at the touch of a button, the fiscal impact of these factors on your MTM from one day, or one period, to the next.

It is possible to know, at the push of a button, all of the following:

  • loan pricing variations,
  • changes to the existing pipeline eligibility,
  • new loans coming into the pipeline,
  • loans that were relocked,
  • loans that were cancelled,
  • loans that were taken out of commitments, and/or
  • loans that were purchased.

On the trade side, you can now immediately understand the impact of:

  • new trades,
  • changes to existing forward commitments,
  • new commitments,
  • newly filled commitments,
  • newly filled; or
  • closed trades.

Knowing this information helps you make the right decisions, with the right information, at the time when the decision needs to be made.

As you continue to invest in your loan tracking and pipeline management systems, it is not unreasonable to insist that you have this information at your fingertips before you make critical hedge position and loan sale decisions.

MARGIN CALLS AND MORTGAGE BANKERS

The recent market volatility has been incredible.  It has caused unprecedented, if not unexpected, disruptions to broker-dealer credit availability resulting in an increase in the trend towards margin calls.

It was 2006 when one of our mortgage banking clients first was approached by a broker-dealer with a request to post margin.  At the time, the client chose to expand their lines with other broker-dealers rather than put money up.

My how times have changed.

While there still are opportunities out there to secure lines without a margin account, the trend is going the other way.  Over the years, broker-dealers have afforded mortgage originations with great credit. From time to time, to their detriment. 

We get it that no one wants to tie up capital unnecessarily.  However, given the exposure that quality broker-dealers have endured over the years, it is time for originators to recognize that risk and be open to reasonable discussions about posting margin to ensure the continued symbiotic relationship between Wall Street and Main Street.

VOLATILITY AND BEST EFFORTS MANDATORY SPREADS

There are many reasons for the fluctuation in spreads between best efforts and mandatory pricing.  One clear trend, however, is that in times of great volatility, the spreads tend to widen.

During volatile times, pull-through can suffer and as a result, investors may increase their hedge costs which, in turn will widen spreads. This certainly occurred in the fall of 2009 and persisted into early 2010.

Recently, we have seen investors become cautious about overloading their fulfillment operations. As a result, they have tampered their best efforts pricing.

The result is the same: increased spread between best efforts and mandatory delivery pricing. A quick study show that this increase in pricing spreads across the board.  If you would like the details do not hesitate to contact me.

We are often asked by prospects during times when spreads are low why they should bother with hedging if the spread is only 15 bps. The answer is to put yourself in a position to take advantage of episodes when the spreads widen.

Unfortunately, converting to mandatory delivery takes preparation. If you wait until the spreads are at their widest, you may miss the window in preparation.  There is a reason why the bigger mortgage bankers focus on mandatory deliveries - even when the best efforts-mandatory spreads are smaller.

HEDGE EFFICIENCY

At Secondary Interactive, we have had countless discussions about measuring hedge efficiency.  Again, this is a concept that is discussed often but rarely is it accurately defined.

The Garret Watts Group talks of the concept of leakage.  We have a client that uses our reports to realize what he calls "findage" - presumably the complement to leakage.

The critical conclusion is that the more you know about your data, and the more accurate that data is, the better decisions you can make about setting your hedge position and, perhaps more importantly, selling your loans.

You now have the ability to understand quantitatively what the potential mandatory pick up could be the day that you provide the lock commitment to the borrower and, more importantly, understand how much of that spread you actually were able to capture when you sell.  In our book, that is how you manage hedge efficiency.

The next step is to identify specifically why you failed to realize the entire potential margin.  There are obvious reasons, such as bid/ask spread, and less obvious reasons, such as failing to deliver to the best execution, missing delivery deadlines and, of course, an in efficient hedge position. 

Understanding these specifics is not unreasonable. We strive to continue to get more and more specific information to our clients so they can improve your performance and reduce their leakage and there is no reason that you can't expect that same sort of effort from your partners.