Within the lending industry,meeting mandatory commitments is a useful way toboost profitability, especially within a highly competitive market. However,the tactics of how to do it profitably are often misunderstood by many lenders and can have devastating consequences if not done properly.

By looking at the risks and reviewing the ways to succeed, lenders can improve their ability to better evaluate whether or not mandatory commitments are a viable way for their organization to boost profitability. Wise lenders interested in dealing with mandatory commitments budget for potential higher losses and penalties by maintaining liquidity, using structural and market hedging tools, and/or better capitalizing just in case they are unable to provide enough loans to meet investors’ criteria. Otherwise, lenders are forced to take a financial hit that reduces revenue and profitability.

The key to meeting mandatory commitments is managing loan data efficiently. Successful lenders use this data to develop and maintain their awareness of the loans being pooled to make sure they all meet the criteria requested from investors. The increased awareness of loan data enables lenders to put together pools of loans faster and more efficiently, making them more profitable and more successful.

Is it for you?
Most lenders that take advantage of mandatory commitments are those with the experience and resources to efficiently manage the data used in preparing pools of loans. However, smaller lenders can still compete by focusing and becoming experts in a particular loan market type, such as fixedrate, conforming, 30-year loans or government-backed loans.

Specializing in loan types enables these lenders to better manage their loan data because they can master the subtle differences of their investors’ requirements. As long as smaller lenders are able to manage loan data quickly, efficiently and with minimal errors, they have passed the first prerequisite to enjoy the added profits generated through mandatory commitments.

Lenders should stay away from mandatory commitments and focus on meeting best efforts deadlines when their loan volume is consistently so small that their back-office staff is relatively inexperienced with the investor guidelines, or if they lack the business processes and systems to efficiently manage loan data.
The only way to produce a pool of loans that meets investors’ desired criteria is to have a complete, accurate database and to have business solutions that enable lenders to keep track of the loans they have so they can accurately match them with investors’ criteria. The most effective solution that can do this is comprehensive secondary marketing and risk management software.

Some lenders try to use spread sheets as a replacement for a secondary marketing software system because they do not understand the difference between the two. Spreadsheets are an analysis tool and do not automate the management of loan data and cannot match loans with investors’ criteria without exposing lenders to very high levels of risk due to errors. Spreadsheets are comparatively inexpensive in the short-term, if you overlook the inevitable penalties of failing to meet mandatory commitments.

Secondary marketing software reduces risk and enables lenders to seize profitable opportunities that they otherwise might have missed. By automating the process, lenders can reduce costly errors that incur penalties and might even drive a lender out of business.

For example, warehousing loans can become a major issue among lenders not using a secondary marketing system, especially if they rely on spreadsheets to manage loan data.

When loans are deemed unsaleable by virtue of their noncompliance with investor guidelines, a chain reaction is initiated that can have very negative consequences for the lender. First, a portion of the lender’s warehouse line or liquidity must be used to board the loan. If the loan is in warehouse too long, higher borrowing rates are often charged, yielding a negative interest spread to the lender.

Too many loan repurchases can damage the relationship with the investor. A compromised warehouse, liquidity and investor relationship, in turn, can slow down the ability to attract new mortgage business and fund new pipeline closings. In this scenario, the production team, the investor and the warehouse lender are all upset with the lender. A secondary marketing system makes it easier to move loans out of warehousing and helps keep the pipeline from backing up with too many unsold loans. This reduces the risks associated with holding onto loans as lenders seek new investors.

Secondary marketing systems offer a higher level of security and transparency than spreadsheets, which can easily incorporate incorrect data. Mistakes often occur when lenders retype data from an LOS system or other software system into a spreadsheet. Secondary marketing software automatically imports and exports data, eliminating errors and reducing the time needed to transfer the information.

Another, more surprising, source of bad data is staff members corrupting the spreadsheet, either intentionally to cover up errors or unintentionally. Either way, spreadsheets were never intended for the rigors expected of a data control system. Secondary marketing tools have automated systems in place that doublecheck data and alert lenders when the data seems questionable. This enhanced level of internal control helps lenders make better secondary marketing decisions, which enables them to avoid risk and generate additional profits that are unavailable to optimistic spreadsheet users.

Mistakes or mismanaged data can prove costly to lenders who have to pay financial penalties. One of the worst things that can happen to a lender using bad data is losing track of loans being pooled and double or even triple selling a loan. Lenders that cannot trust their own data completely should not be in the business of meeting mandatory commitments, due to the massive penalties involved. Having an automated system of checking the data is an essential tool for anyone in the business who wants to be successful.

Handling sudden changes
Secondary marketing systems are also better able to deal with sudden changes in the market that can hinder lenders’ abilities to correctly match loans with investors.

One of the most memorable examples of a market change occurred as the refi boom went into full swing, catching many lenders unprepared for the dramatic rise in loan volume. Lenders using secondary marketing systems were able to manage high volumes of loans and analyze their data correctly to meet mandatory commitments, while many without the proper software failed to provide accurate data on loans. They had to either pass on meeting mandatory commitments or had to absorb penalties incurred from mismatching loans to investors.

Managing loan data correctly will become even more important as a tool for minimizing risk this year because of increased competition for investors. Interest rates will continue to rise, creating more competition for a smaller number of investors. Many lenders focusing on meeting best efforts commitments may be forced to try to meet mandatory commitments, reducing the demand for profitable loan pools. The most effective lenders will be able to retain their key investors.

Lenders that cannot efficiently meet mandatory commitments risk becoming overly dependent on one or two key investors. If their investors face a reduction in their own liquidity or product appetite, those lenders may find themselves abruptly faced with the dilemma of being unable to sell loans at market-price levels needed to preserve capital, let alone a profit. The timeless investment recommendation to diversify rings true in this case, as well. Lenders should position themselves to always have a viable alternative outlet for the loan products they market.
Lenders need to weigh the financial benefits of utilizing mandatory commitments against the risks in order to maximize profitability. The size of lenders makes less of a difference than their ability to effectively manage data, which enables them to meet the conditions required for mandatory commitments.

Meeting mandatory commitments is not for every lender and should not be viewed as an easy way to make big profits. The risks and due diligence required to be successful, however, do make mandatory commitments a good way to enhance profitability for lenders that are organized, forward thinking and willing to invest in utilizing wise business practices and technology.

Greg Crosby manages the secondary marketing software and services product line having joined ASC in June 1997. Greg has been involved in the mortgage industry since 1981. His fields of experience include secondary marketing, financial and performance auditing, construction and design of financial conduits, software development, commodity and securities portfolio management, and design of risk assessment systems. He developed the Risk Manager and Servicing Shepherd™ software products. Greg has served as a chief financial officer, with both commercial banks and investment securities brokerage firms, and has served as an advisor and board member to companies ranging from service providers to financial conduits. Greg is considered an industry expert in the fields of secondary marketing and risk management has authored numerous articles, papers and a book titled The Theory and Practical Application of Improving Secondary Marketing Performance with Software Tools.