Secondary marketing is just not what it used to be. In the past five years, the mortgage industry has gone through two volume waves that have changed the way secondary marketing teams do business.

The first wave was produced by historically low interest rates, which caused an onslaught of people refinancing their mortgages, as well as new home purchases. The low interest rates increased consumers’ purchasing power and gave them the chance to afford more house for their money. The low interest rates also enabled many renters to purchase homes. All these circumstances transpired to create the largest loan volume that the mortgage banking industry has ever seen.

As the interest rates started to rise above these historic low levels, the second big wave of originations began as borrowers were introduced to new mortgage lending products, such as interest-only loans, products requiring little or no down payments, and hybrid adjustable-rate mortgages (ARMs).

ARMs gained popularity because mortgages that were priced based on a one- to five-year interest rate reset window had a substantially lower interest rate than one that was fixed for 30 years. Hybrid ARMs appealed to many borrowers due to the “house flip” mentality and the increase in home values.

The house flip, or trading mentality, created a huge demand in home sales, drastically increasing mortgage activity. Lenders, especially in the home equity and nonprime space, initially resisted increasing rates in order to encourage greater demand for lending products, but market conditions gradually changed and rates inevitably started to rise.

With interest rates going up and the creative financing products becoming less appealing to borrowers, there is now a consensus that, at long last, the refi boom is ending.

The impact of recent hurricanes is another factor mortgage lenders must consider. The reconstruction along the Gulf Coast will generate additional economic activity. However, reconstruction requires the government to float more deficit and more bonds, which inevitably further raises interest rates. Increased demand for money places upward pressure on interest rates throughout the country and further reduces loan volumes for all lenders.

With the recent changes in the mortgage industry, many secondary marketing professionals are asking themselves questions such as: What should I do to protect my current profitability? Do the current market conditions change my hedging and management approach? How do I position my business to reduce risk?

Assess your product mix
One of the primary actions that secondary marketing teams need to take is to assess if their product mix is ready for changes in the market. For example, mortgage lenders heavily focused on subprime lending should consider broadening their product mix. By shifting focus just a bit to utilize more diverse lending products, secondary marketing teams will attract more investors and sustain investor confidence in a changing economic environment.

The mix of popular lending products includes prime, subprime, Alt-A loans, fixed-rate mortgages, ARMs, first liens and home equity mortgages. Changing market conditions continue to shuffle the deck of borrower preferences and the ability of lenders to meet borrowers’ needs. None of these products is consistently “better” or offers guaranteed avenues for profitability.

However, offering a variety of loan products is a historically tried and true strategy to hedge against an uncertain future because it increases the resilience of mortgage lenders’ product volumes and potential profitability.

As the loan volumes continue to decline, there will be added pressure on the earnings margins for mortgage bankers. Therefore, their hedging approach, no matter whether it is structural, natural or through trading, needs to be as efficient as possible. This will require secondary marketing teams to evaluate their hedging processes and ensure that they are maximizing potential profitability and reducing risk. Otherwise, they may not have the margins that they need. Failing to do so will put them into a noncompetitive position that will further exacerbate the volume issue.

Two areas where most secondary marketing teams can further improve their capabilities are production process management and mortgage pool aggregation.

Lenders must focus on the returns their mortgage production teams are yielding. Here the volume and profit margin for closed mortgages is qualified by such factors as the volume and cost of applications that did not close or were closed only after concessions of rate, price and/or time.

By tracking loans that were kicked back by investors and studying the length of lock term granted, the time actually required and the nature of the product selected, lenders can find patterns that enable them to make wiser choices and boost profitability.

Mortgage pool aggregation can be improved by seeking to best match product pricing with investor appetites. Conducting a sound loan pooling and delivery process requires management of four important issues: investor integrity, commitment integrity, pool integrity and data integrity.

Investor integrity. This covers making sure to deliver eligible loans to investors.

Commitment integrity. When delivering loans to meet an investor’s standing commitment, sellers must be able to monitor what they have delivered so that they can take action to make sure there is a continued delivery mechanism in place.

Pool integrity. While the commitment constraints tend to be on a macro scale, the pool-level constraints tend to be more micro in nature. Typically, the negotiated pool terms will control the product types and dollar amount of loans to be delivered at a specific price.

Data integrity. The quality of data is critical. If the data is questionable, monitoring investor commitment and pool-level integrity issues is a waste of time and long-term profitability is threatened.

Understand market exposure
Mortgage professionals also need to understand their market exposure at a stratified level. The risk management function is one of insuring against risks. Universally, one will be most cost effective when selecting insurance coverage or self-insuring once a clear understanding of exposure is achieved. The other common method of reducing insurance costs is to introduce structural/process changes that inherently reduce exposure.

For example, a pricing policy that seeks to minimize actual lock periods and/or stabilize loan fallout experience would reduce market exposure. Like all structural changes, they are not free. As such, the decrease in volume and/or prehedge profit margins would need to be weighed.

The market is changing for secondary marketing teams. Interest rates are moving up, and the latest creative lending products are losing their edge, which directly impacts the profitability these teams are tasked with protecting. By taking practical, common sense steps, secondary marketing teams can better position themselves to protect what they have and outperform their competitors.

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.