Operations & Hedging Advice To Mortgage Execs
Are you the CEO, President, CFO, or head of Secondary? If I were to walk into your company, right now, and ask: What is your company making (in basis points)? What is your gross or top end number? What is your net or bottom line number? Do you know? Would you be able to go directly to an excel spreadsheet and point to your GOS (?); your gross and net numbers? Do you know what it takes from a volume perspective to break even at your current profitability levels? Do you know how many basis points it takes to originate and fund a loan?
You would be surprised at how many people don’t know…
It is the job of the Secondary Marketing Manager (“SMM”) to ensure that the profit margins given to him/her by the Business Head are achieved when the loans are purchased. In most cases, the SMM is responsible for the lock desk. They are responsible for the pricing on the rate sheet. This means they are responsible for making sure that the pricing on the rate sheet has the necessary margin built in to achieve the profits the Business Head requires.
After every loan sale, a spreadsheet should be produced that provides Executive Management with the ‘Buy’ price, the ‘Sell’ price, the hedge gain/loss, and the net margin, at minimum. In addition, if you are able to track expected margin within your MIS (Mortgage Information System), this will provide the Business Head with a perspective as to how the SMM is doing in achieving his/her goal of bringing in the margin that was used to build the rate sheet pricing. This spreadsheet should also incorporate all trades month to date. The trade should be listed in chronological order and the monthly weighted averages should be tallied for each individual category.
In addition, the SMM is responsible for monitoring lock extensions, renegotiations, and program changes. Leakage, for purposes of this article, is defined as the amount of negative differential (in basis points) between the margin used to build the rate sheet and what was actually achieved when the loan/s are purchased. This is the nemesis of all SMM’s. In a culture where pricing on the rate sheet is changed ‘willy-nilly’ (a very technical secondary marketing term) based on how favorable/unfavorable a firm may look on a pricing comparison of their competitors, is a Leakage based environment. Waiving, willy-nilly, extension, renegotiation, and program change fees, is a Leakage based environment. Whether you sell loans on a Best Efforts basis or you hedge and sell on a Mandatory basis, you are being charged those fees. You MUST recoup a large majority of those fees. If you don’t, you won’t achieve the margins the Business Head has prescribed and your job could be at jeopardy. Are you delivering your loans on time? Or, are you constantly asking for extensions from your investor because your shipping/post-closing department is unable to deliver the loans within the prescribed commitment period. The investors don’t extend for free! This is Leakage.
Finally, are you reconciling your purchase advices with your investor? You would be amazed at how many loan purchases are done incorrectly, in your favor and out of your favor. Please, please, please, begin a process, whether it’s in Secondary or in Accounting, where you are reconciling the price the loan was sold to the price actually received. People make mistakes. When they do it creates Leakage. It is imperative as an SMM to make sure that you are receiving what you expect!
So what is or what are the solutions?
First and foremost, the Business Head must be on board with the changes you’re about to make. If he/she is complicit with the culture of chasing a spot on a rate sheet comparison or allowing the ‘willy-nilly’ fee waivers to occur, you have no recourse or way to push back. If this is the case, you must be very clear with your boss that there is no way for you to be held accountable for the lack of profit margin.
If the Business Head agrees with the changes, here are some specific ways to manage these processes. There must be in place a directory of all programs and the intended profit margins the company is to earn. This is a listing by business line (wholesale, retail, direct to consumer, etc.) of the products and the profit margins. In addition, there should be a gatekeeper. This person is normally the one who issues the rates in the morning and any intraday changes that might occur. At the bottom of the directory, there should be signature lines with the requirement that the SMM and the Business Head should sign if there are any changes to the margins. Once a decision has been made to change the margins, the signatures must be obtained prior to implementation.
Next, it doesn’t matter if you are in a Best Efforts or Mandatory environment. The waiver of lock extension and renegotiations is a killer. For example, currently roll costs of TBA MBS for a current coupon FNMA 3.5 is about 10/32. If you divide 10/32 by 30 days, it costs the company that’s hedging and selling on a mandatory basis about 1.04 basis points per day. Let’s round to 1 basis point. Thus, to extend for 15 days, it costs 15 basis points. In addition, there are human resource costs in generating the lock extension. The lock desk personnel that are performing the actual extension. . . The operations staff member requesting the extension. . . These are actual costs. If you’re selling on a Best Efforts basis, this is how your Correspondent Investor is calculating the cost to extend your Best Efforts commitment. Also, if you attempt to ask for the extension after the lock has expired, all bets are off because the mortgage banker that hedges or the Correspondent Investor has lifted the hedge for the particular loan you’re working on. Thus, there’s nothing to extend. The commitment is gone!
There are many other discussion points along these lines. I hope this gives you at least some pause to begin to consider how to ensure that the margin you’re supposed to achieve is at least close to what is coming in the back door when the loans are purchased.
–by Brad Nease, Senior VP Capital Markets, Carrington Mortgage Services (Brad.Nease@carringtonms.com)