REQUIRED READING: People in the mortgage banking industry are beginning to talk about the ‘new normal.’ The notion is that after years of unusually robust economic growth, we've fallen into a period of weak demand so pervasive that it requires a complete reassessment of our priorities and future expectations.
Origination volume has dropped from a peak of $3 trillion in 2005 to an expected volume of less than $1 trillion in 2012 – a level not seen since 1997. With faint hope of near-term recovery, mortgage lenders have to do more than just hunker down. They need to think strategically about a future that demands a leaner, more efficient business model.
Technology will obviously play a large role in this redefinition, but the question lenders need to ask themselves is where to apply technology in order to improve profitability.
From a secondary marketing standpoint, profitability is measured by the amount of gain earned off loans sold to investors. This gain is simply the difference between the price sold to originators (the buy-side position) versus the price sold to investors (the sell-side position). As long as the originator's price is accurate and the investor is providing the best possible price at delivery, lenders optimize their revenue efficiency and ensure themselves a high margin per loan.
In order to improve profitability, lenders need to protect their buy-side and sell-side positions. On the buy side, that means the price provided to originators is accurate. We are not talking about being close to accurate, but bull's-eye accurate. That means rates must be to-the-minute current, and all loan-level price adjustment must be precisely factored in. If either of these figures are off – even slightly – then lenders lose out because they take the hit to pricing and bear the margin reduction.
Secondary marketing managers will point out that they can compensate for any missed buy-side gains to the extent that it does not result in a net loss. One-eighth of a point on a $200,000 loan might only be $250, but when the Mortgage Bankers Association reports that average profit per loan in the second quarter of this year was only $575, you're talking about losing practically half of your profit. This leaves little room for other potential losses.
For the most part, lenders are using product and pricing engines to efficiently handle buy-side pricing. These systems automate investor rate sheets and price adjustments to provide timely and accurate determinations of price – a huge improvement over rate sheets taped to a wall. More importantly, product and pricing engines are used where mistakes are typically made, at the point of sale with the originator.
But one important aspect that product and pricing engines cannot handle is the impact of underwriting to investor overlays and how it leads not only to worse pricing, but also lower pull-through rates and a less-efficient workflow.
Most mortgage lenders leverage relationships with multiple investors in order to maximize their sell-side price. Using a best-execution model, originators simply choose the investor that offers the best price at a given note rate. However, not every investor product is exactly alike. There are specific investor overlays that alter a borrower's ability to qualify for a product, and many of these overlays are dependent on data that can only be found buried deep inside a credit report, such as bankruptcy or foreclosure information.
Because of their inability to read credit-report data, product and pricing engines are unable to detect these differences in investor overlays. Most only go as far as an originator typing in a borrower's FICO score. As a result, originators are at risk of selecting a best-execution price from an investor for which the borrower does not qualify. Once the loan has been underwritten, secondary marketing is then forced to find an alternate investor that will accept the loan, but at a worse price. As demonstrated above, even a small reduction in price can have a large impact on profitability.
The second problem created by this scenario is that if secondary marketing has gone to the extent of locking with the wrong investor, subsequent determination of ineligibility will have a negative impact on pull-through rates.
That is why automated underwriting makes a difference. It enables originators to determine whether a borrower meets investor overlays before pricing is even introduced. Lenders can utilize best-execution strategies more effectively and eliminate any potential losses due to the incorrect qualification of loans.
Moreover, pushing underwriting to the front of the origination process, reduces the volume of poor-quality loans that reach the production pipeline and improves a lender's pull-through rate. Workflow efficiency is enhanced, and lenders benefit from preferential pricing with investors.
The takeaway is that decisions made at the point of sale have a huge impact on a lender's profitability. Being able to accurately determine both eligibility and price are essential to maximizing secondary marketing gains. It also demonstrates that secondary marketing itself needs to play a larger role in the application of technology and workflow, because it can make or break a lender's ability to efficiently generate revenue.
In this age of uncertainty, mortgage lenders are forced to evaluate their business model from all sides. By providing originators and secondary marketing with technology that enables them to make more reliable decisions, lenders can protect their profitability and lay the foundation for success in the ‘new normal’ world of mortgage lending.
Linn Cook is marketing director for LendingQB, headquartered in Costa Mesa, Calif. He can be reached at (888) 285-3912.