Making the switch to mandatory loan sales

by Ryan Smith23 Nov 2020

Market volatility in 2020 – fueled by the economic uncertainty around the COVID-19 pandemic, actions by the Federal Reserve, rapid rate changes, and more – has been challenging for participants in the secondary market, to say the least. These conditions have created pipeline-management issues for many lenders.

That’s why – for lenders who are ready – there’s never been a better time to transition from best efforts to mandatory loan sales, according to Mortgage Capital Trading (MCT). The company recently released a white paper detailing the advantages of making the switch.

“We work with lenders who sell their loans on the secondary market to investors,” said MCT chief operating officer Phil Rasori. “Many lenders need to sell that loan and get the capital back so they can continue to make loans again. We help lenders improve the profitability of their loan sales while also mitigating the risk of market movement.

“There’s basically two types of processes for selling loans,” he said. “The first process for most lenders is called best efforts. That’s the process you start with. If a lender can grow to around $10 million per month, that’s the target for switching to mandatory loan sales.”

A best effort mortgage lock transfers market risk from the originator to the investor, Rasori said.

“A homebuyer locks their rate in, and, for example, it takes 60 days for the loan to close and fund. As soon as you lock that rate in, the lender is obligated to honor that rate commitment. At the same time, markets may move and the value of the loan may change. In order to mitigate that market risk, the investor would hedge that loan using to-be-announced (TBA) mortgage-backed securities. What that’s basically doing is saying, I lock the customer in at a rate of 4% for a $400,000 loan. The buyer of the loan is going to take a short position, which is basically betting against the loan. They assume it’s coming through the pipeline, and they’re going to bet against the mortgage-backed security. When the value of a loan goes up, so does the value of the mortgage-backed security.

“When a lender grows large enough, it’s often a good idea to switch to mandatory loan sales – in which the lender takes on that market risk itself. Lenders need to have enough capital on hand to fund loans and also take a short position on mortgage-backed securities,” Rasori said. “Now you’re hedging that loan internally. You want to make sure you budget appropriately and calculate your pull-through correctly. The good thing, though, is if you take that risk and don’t make the investor do it, you make more money when you sell the loan to the investor.”

Taking on that risk does expose lenders to more market volatility.

“When the markets were volatile in March and April, from day to day and week to week, the value of that loan could change tremendously,” Rasori said.

However, lenders who hedge correctly can protect themselves from much of that volatility. According to the white paper, lenders who adopted mandatory loan sales were able to mitigate much of the Q2 2020 volatility risk through a conservative hedge strategy. Clients who implemented that strategy with MCT saw an average pickup of 100-plus basis points through the height of the volatility.

Rasori said that MCT could help lenders make the switch from best efforts to mandatory sales.

“We’re looking for lenders who are selling on a best effort basis who either are doing more than $8 million-$10 million a month in volume or they’re starting to get big enough to switch to mandatory loan sales,” he said. “We can help them make that transition from best efforts to mandatory. We have a huge referral base for the accounting and underwriting transitions they’ll need to make. We have a centralized lock desk they can leverage and industry experts who can work with them closely. We also have robust, award-winning software they’ll be able to leverage.”

“We help them improve profitability on every loan that they sell,” Rasori added. “Innovative software for loan pipeline management, industry-leading expertise, and five divisions to help them with everything they could ever need – hedge advisory, mortgage servicing rights, lock desk, business intelligence, investor services and more.”

To find out more about how making the switch to mandatory loan sales can boost profits, check out MCT’s white paper here.