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Handling the refi boom.

Lenders faced a full-fledged refi boom when rates sank to the lows reached in January.

Volume soared, stretching lenders' ability to lock loans and get them closed.

But technology made this year's refi boom easier to handle than previous booms.

A refinancing boom puts everyone in a mortgage company on the front lines, and secondary marketers are no exception. High levels of new volume as well as large numbers of payoffs concern most of the organization. But the secondary marketing staff is making sure the money to fund loans is available and well priced. Coping with pipeline fallout rates that are more variable than usual, a warehouse credit line that may be stretched to its limit, servicing hedges that are challenged by unanticipated payoffs, and then selling new production on favorable terms all confronted secondary marketers when rates dropped in January.

But they seem to have done quite well managing the volatility of the first quarter of 1998 - even though it was somewhat unexpected. "We knew there was a good chance that if rates continued to slide at the end of 1997, we would have a mini refi boom," says Joe Bowen, executive vice president of secondary marketing at AccuBanc Mortgage Corp. in Dallas. But because of the large number of adjustable-rate mortgages originated over the past few years - whose owners found January to be a great opportunity to secure fixed-rate financing - it soon became "more than a 'mini' refi boom," Bowen says.

"The overall industry was not expecting a decline in rates, which would heat up a refi boom quickly," says Cheryl Glory, director of the residential mortgage structured finance group at Fitch IBCA, Inc., in New York. She notes that mortgage bankers who already had been staffing up their retail branches or building a telemarketing unit as part of a strategic plan "have an edge over lenders starting those activities now that a refi boom is here."

Investment returns

Glory adds that the 1998 refi boom showed that technology investments in underwriting and servicing are paying off now.

"This year's refi boom was much more manageable" than previous ones, agrees Cathy Stickelmaier, vice president and secondary marketing manager at First of America Mortgage Co. in Kalamazoo, Michigan, which recently was purchased by National City Mortgage Co. in Miamisburg, Ohio. "We use Fannie Mae's Desktop Underwriter on laptops at the point of sale," she notes. With the help of the agency's automated underwriting system, the company gets point-of-sale approvals 50 to 60 percent of the time, Stickelmaier says. She adds that First of America had been working with the system for more than a year and had distributed laptops to all loan officers by the end of 1997.

New approaches are still being evaluated throughout the industry. Glory notes that streamlined refinancing guidelines have helped lenders this year. For example, Fitch IBCA typically is comfortable with drive-by appraisals if they occur within four years of the loan's origination. Automated appraisals also can be useful in looking for overall declines in real estate values within a market, she adds. Generally Fitch IBCA finds them appropriate for refis if the lender is using the automated appraisals on its own servicing clients who are up-to-date on payments, and when the existing loan is less than four years old.

Quick response

Combining these technologies with effective customer interaction helps lenders respond when rates are moving quickly. Glory says some lenders can transfer a call requesting payoff information to a loan officer who can pull up a credit report on the spot and seek to refinance that servicing customer immediately.

Many mortgage bankers have set up telemarketing units to respond to servicing customers looking to refinance. When combined with the lessened processing and documentation requirements of streamlined refinancings, it made it easier for lenders to close loans early this year. And, as Stickelmaier notes, "there's nothing worse than the refi that won't close." Lenders then have increased fallout as borrowers find a better deal with another lender - or seek to renegotiate after locking a loan, if rates drop further.

Streamlined refinancing procedures also "saved us from the train wreck" in the back office, she adds. Most lenders say that the refi boom stretched their processors and closers more than any other department in their firm. Production more than doubled in one week for some lenders during January, says Paul E. Tuttle Jr., managing general partner at Tuttle & Co. in Mill Valley, California. "Not many were prepared for that," he adds. Margins widened as a result, says Tuttle, and he estimates that servicing-released premiums shrank by 15 to 25 basis points.

Unexpected demand

Such high levels of refinance loan volume were unexpected for good reason - they simply hadn't occurred before. Stanislas Rouyer, assistant vice president and analyst at Moody's Investors Service in New York City, says that although February was a short month, Countrywide Home Loans in Calabasas, California, originated $6.24 billion. Countrywide's previous peak production month was December 1993, which totaled $5 billion.

Rouyer says most lenders would have estimated that their peak funding ability was actually 20 to 30 percent lower than what they achieved in the early months of this year. "Lenders were stretched to the limit," he adds, noting that the staff would have burned out shortly if the boom had kept going. Using temporary workers, overtime hours and switching staff between departments were common ways of handling the unexpected volume, Rouyer says.

Rouyer adds that the largest lenders were more than able to recapture runoff, and he thinks "smaller, less marketing-oriented companies" were less likely to replace runoff than were national lenders. Yet closing loans during a refi boom is especially important for smaller lenders, Tuttle notes. A large increase in volume brings additional costs of hedging and underwriting. Not closing enough loans can eat into what soon becomes an overleveraged capital base.

Wholesale lenders also tend to have greater fallout than retail shops, Tuttle says, because retail customers are less prone to shop for a better deal. Yet despite lenders' emphasis on retail and telemarketing originations, during the refi boom correspondent and wholesale lending seems to have held its own. Bowen adds that AccuBanc had planned on 55 percent of its production coming from mortgage brokers this year. But by March, that had increased to 65 percent of the firm's volume.

Rick Cossano, Countrywide Home Loans executive vice president of wholesale lending, notes that mortgage brokers help busy consumers shop for a loan. Countrywide's wholesale division grew to become the company's largest distribution channel in the 12 months ending February 1998, according to company figures. More than $2.2 billion brokered loans were originated during that month, an increase of 287 percent from a year earlier. However, Countrywide's Consumer Markets channel grew a bit more on a percentage basis, by achieving 300 percent growth during that period.

Secondary issues

Fallout rates didn't pose a problem for most lenders during the first quarter of 1998, say industry observers, as they rose to an average of about 30 percent during the refi boom. Yet some lenders saw their fallout ratios jump as high as 60 percent, claims Tuttle. "Having the level of sophistication to be able to predict fallout at the loan level is critical," says Blake Wilson, executive vice president and director of capital markets at HomeSide Lending, Inc., in Jacksonville, Florida.

Different hedging philosophies are used in the industry, and all seem to have worked adequately for lenders this year. Often lenders use mandatory forward commitments on mortgage-backed securities (MBSs) to hedge their pipelines, along with options on MBS and Treasury securities. Some lenders relied more on optional coverage to effectively hedge the greater amounts of loan fallout early this year. Rather than trying to forecast fallout, AccuBanc Mortgage only hedges loans that are "underwater," says Bowen. Hedging costs then won't reduce profits on the rest of the pipeline, he explains.

AccuBanc anticipated falling rates during the second half of 1997, Bowen adds, and sold some servicing as a result. It also set up a telemarketing unit to refinance customers last September. Automated lock-ins at the branch level was another new system recently introduced by AccuBanc. Bowen notes that of the $100 million it was locking daily during the refi boom, only 5 percent to 10 percent had to be done manually. AccuBanc took in this year's increased production without having to hire anyone in secondary marketing, he adds. Other firms struggled with loading their lock-ins, says Madeline Johnson-Oler, a consultant with Mortgage Dynamics, Inc., in McLean, Virginia. Heavy volume meant that some were two to three days behind in accomplishing this task.

Testing hedges

Additionally, AccuBanc set up a servicing hedge to offset possible balance sheet impairment as a result of portfolio runoff. Currently AccuBanc hedges 21 percent of its servicing portfolio - up from 10 percent earlier this year, says Bowen. Yet because it originates $9.5 billion annually and has $10 billion in servicing, runoff is not hard to replace at AccuBanc, according to Bowen.

Servicing hedges were given a harsh test during this year's refinancing boom. Most did well, according to secondary market observers. "We were very, very satisfied" with the performance of HomeSide's servicing hedge, Wilson says. Having a hedge in place before rates fell was critical, adds Mortgage Dynamic's Johnson-Oler. Moody's Rouyer agrees that some lenders who did not hedge have suffered dramatically from runoff.

Yet Johnson-Oler notes that re-creating loans through originations is cheaper than hedging. Each company must estimate how much business this "natural hedge" will bring in during a period of falling rates, says Johnson-Oler. Finding the right hedging strategy involves company-by-company decisions, adds Don Palumbo, a senior consultant at Mortgage Dynamics, who points out that certain hedging instruments are more appropriate for portfolios with specific risk characteristics.

Smaller servicers could find the challenge more than they're willing to accept, says Rouyer. "A lender with a medium-sized portfolio can't afford to hire a sophisticated person to hedge its servicing," he explains. "Some might see the risk as being beyond what they can afford and sell servicing."

Rouyer believes this situation could spur more mergers and acquisitions of mortgage firms. While most previous mergers have been between financial institutions, rather than between pure mortgage banks, Rouyer predicts future acquisitions could be driven more by mortgage banking considerations.

Closing delays

Operational delays in closing loans meant that loan locks on HomeSide's correspondent and wholesale business increased from a typical range of 45 to 70 days to more than 70, Wilson says. More extensions and relocks than usual also were seen, he says.

Longer locks also lead to more fallout. Bowen notes that over a third of AccuBanc's production comes from California, where lock-in periods of two to three weeks are common. Shorter average lock-in times encouraged more than three-fourths of AccuBanc's locked loans to close during the first quarter of this year. Another advantage of the shorter lock-in period is that not all loans then are scheduled to close at the end of the month, he says.

Yet the refi boom still stretched AccuBanc's warehouse credit lines, according to Bowen. Adding some gestation lines from Wall Street helped, he says, along with faster execution of sales.

However, operational difficulties still complicate the lives of secondary marketers. "Title companies can only close so many loans a day," says First of America's Stickelmaier. "There's a mountain of documents that must be prepared." She thinks that the industry has "streamlined applications and underwriting, but our hands are tied by RESPA on closing and postclosing."

Lenders wanted to close loans quickly to reduce fallout and then pass them rapidly on to investors to take pressure off their warehouse lines. AccuBanc was able to go from loan funding to sale in 15 days during the refi boom, according to Bowen. Its loan mix helped, he adds.

In early 1997 the AccuBanc's originations were 70 percent fixed-rate loans. But this year that changed to 95 percent fixed-rate mortgages. Most often AccuBanc does whole-loan sales of adjustable mortgages to large financial institutions. As a result, "ARMs require more hands-on staff to deliver to an investor," Bowen notes.

New fallout assumptions

First of America saw its normal pipeline fallout move from 17 percent to 18 percent to 24 percent to 25 percent in January. Looking at each loan's locked rate and the time remaining on the lock allowed First of America to predict fallout on the firm's all-retail originations.

However, Stickelmaier notes that in 1995 consumers were renegotiating or finding another lender for just one-quarter to one-eighth of a point - less than they had required in the past. "Borrower behavior changed," she says, which resulted in increased fallout.

However, sophisticated borrowers also were quick to be aware that the time was ripe to refinance. Volume quadrupled in three days in January, Stickelmaier recalls. Overall production for the first quarter of this year was three times larger than what the company had planned for. Average loan size also was up $20,000 to $25,000, says Stickelmaier, since borrowers are refinancing quicker before they've paid down their existing mortgage.

Fortunately, an uptick in the market in February forced many locked borrowers to go ahead and close, rather than trying to get a better deal. Such bond market volatility actually helped secondary marketers in this year's refi boom.

During 1992-93 the bond markets brought one continuous fall in interest rates, Wilson remembers. But 1998 produced a series of quick up-and-down movements in the market. "We've seen three rate cycles in the last three months," Wilson says.

Technology tools

Rapid access to portfolio information helps secondary marketers, Stickelmaier says. Before she had to cope with reports that weren't exactly what she wanted. But now that First of America's secondary marketing department is PC-driven, staff can pull the database out of the mainframe, devise new reports and get the outputs they need, she explains. Training workers also is easier to do on PCs, Stickelmaier adds.

Increasing use of technology - and the fact that they've gone through it before - helped secondary marketers to deal with high volume this year, notes Mortgage Dynamic's Johnson-Oler. Secondary marketing expertise also is rising throughout the industry, Palumbo adds. Mergers have pushed more-astute managers to the fore, he says.

Consumers are refinancing repeatedly, Palumbo notes, often motivated just by a 25- to 50-basis point lower rate. Refinancing booms thus will remain a recurring part of a secondary marketer's job. Johnson-Oler sees the position as evolving into "risk manager for the entire company," which may include secondary marketers playing a role in reengineering, hedging servicing portfolios and evaluating mergers.

New opportunities

Subprime lenders currently don't tend to hedge their pipelines, says Tuttle. Because B and C margins are so large, he doesn't expect to see more risk management to evolve in that niche until there's a sustained bear market, which points out the need for such practices.

Today's need to competitively price conforming loans, subprime mortgages and home-equity credit lines complicates the lives of secondary marketers, Bowen says. He adds that hedging must be applied to pipelines and servicing. "The combination of all these demands can be challenging," says Bowen. Yet although the business was simpler a dozen years ago, secondary marketers adapt quickly today, he claims.

Bowen adds that secondary marketers need to remove the wall between their departments and the production unit. Secondary marketers need to respond quickly to the needs of the production department, he says, as entrepreneurial mortgage bankers move into new market niches. Bowen notes that AccuBanc has outsourced some hedging duties to a specialist firm, giving him more time to work with others as a team - rather than sitting in front of a computer screen watching prices.

The first quarter of 1998 was very profitable from a secondary marketing perspective, Bowen says. High volume, a greater percentage of fixed-rate production, and the ability to increase margins due to heavy demand all contributed to earnings. "As a company, we're elated about the first quarter - and how we handled it," he adds.


A refinancing boom encourages portfolio lenders to look to the secondary for reducing some of their financial risks, says Paul Taylor, senior economist with America's Community Bankers (ACB), a Washington, D.C.-based trade group representing 1,800 thrifts and savings banks. He explains that a refi boom "takes high-yielding assets out and puts low-yielding assets in." Since portfolio lenders gain most of their earnings from the spread between a loan asset's note rate and its funding rate, this effectively reduces a portfolio's profitability.

Mortgages make up about 90 percent of the lending activity by ACB members, Taylor notes. He adds that one difference between the refinancing booms in 1992-93 and during 1998 is that the purchase market this year has been strong - both for first-time and move-up buyers. Refis accounted for 53 percent of ACB member originations in 1993, and 48 percent in 1992. But Taylor forecasts refis will make up just 44 percent of thrift home loans in 1998, indicating a stronger purchase market is present.

Homeowners also tend to prefer fixed-rate loans when rates are low. Yet holding these mortgages in portfolio introduces more interest rate risk to lenders, who prefer adjustable-rate products. Greater interest in secondary market sales can be seen in the rise in percentage of ACB members who sell to the following secondary market outlets:
 1996 1997

Freddie Mac 30.6% 31.4%
Fannie Mae 20.6% 19.6%
Other Financial Institutions 16.8% 17.1%
Conduits 12.5% 16.1%

Taylor notes that conduit sales are mostly of jumbo and nonconforming loans. For instance, he explains, a lot size may be too large to fit into agency standards, and thus require a conduit sale.

Last year about one-third of secondary sales by ACB members were servicing-released, says Taylor. He adds that lenders are using agency origination guidelines more often now than in the past, even if those loans are initially intended to remain in portfolio. Such mortgages "are secondary market ready," Taylor says. "Access to the secondary market is there, even in cases where it is not being utilized."


Growing use of desktop underwriter and loan prospector - the automated underwriting systems promoted by Fannie Mae and Freddie Mac - is leading the agencies to predict that "risk-based pricing" will become the industry norm. Under risk-based pricing each mortgage is priced according to its individual characteristics, reflecting the uniqueness of the borrower, the property, and the loan being applied for.

However, secondary marketers have some concerns about risk-based pricing."When will you quote a borrower a price?" asks Joe Bowen, executive vice president, secondary marketing, for AccuBanc Mortgage Corp. in Dallas. He says that if a consumer calls a branch to ask about current rates, an accurate quote can't be given until the lender knows the loan-to-value ratio, property type and the applicant's credit score.

Bowen also sees the need to attach a disclosure when making these quotes and wonders how that would be done over the phone. "We've tried hard not to have to go to risk-based pricing," he adds. Currently, AccuBanc is testing Desktop Underwriter and Loan Prospector "sparingly," says Bowen. "We're a long way from having a point-of-sale" underwriting and pricing decision available for consumers, he adds.

"Risk-based pricing clearly adds another layer of complexity that I don't think the mortgage industry is ready to handle," says Blake Wilson, executive vice president and director of capital markets at HomeSide Lending, Inc., in Jacksonville, Florida. He notes that the systems and technology needed "are not pushed all the way out to the front line today." Yet, Wilson says that implementation process is happening now. For instance, HomeSide uses a nonagency automated underwriting system, called CreditPoint.

Don Palumbo, senior consultant at Mortgage Dynamics, Inc., in McLean, Virginia, remarks that producing a rate sheet would be difficult when LTV and credit scores aren't known. "You can't compute an accurate LTV until you have the appraisal," he says.

Observers note that risk-based pricing would seem to lose much of its value if approvals also carried contingencies. Palumbo adds that secondary marketers would be pricing loans before determining how they will be sold. Pressure is added on secondary marketers as companies find it's increasingly more important to be accurate on every loan, rather than relying on averages, says Palumbo.

Yet in some ways this dilemma points out the challenges facing today's secondary marketers."As we become much more of a commodity-like industry, there's a critical importance to pricing," says Wilson. "There's no room for error on risk management and hedging." He adds that lenders also need the best possible execution when securitizing loans or selling directly to investors, Doing so is necessary to keep your product competitive, Wilson says. To date, he notes, "systems and technology have evolved dramatically to help us manage these complexities." Challenges associated with risk-based pricing can be seen as another hurdle secondary marketers will have to clear in the future.

Howard Schneider is a freelance writer based in Ojai, California, and a frequent contributor to Mortgage Banking.
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Title Annotation:includes related articles on thrift institutions and securities pricing; refinancing market
Author:Schneider, Howard
Publication:Mortgage Banking
Article Type:Cover Story
Date:May 1, 1998
Previous Article:Systems analysis.
Next Article:Prepayments swamp subprime lenders.

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