Shifting from best effort to mandatory execution marks a significant achievement in the evolution of a mortgage lending organization, as it represents a more sophisticated (and more profitable) secondary strategy. However, lenders are not always clear on the particulars to making this transition and, as a result, may be slower to change and/or experience a more difficult conversion process.
By having a more fulsome understanding of what is required to make this shift, lenders can streamline the transition and begin maximizing their execution strategy sooner.
As the adage goes, one must walk before they can run. However, there are certain developmental milestones one must meet before they can walk, and the same holds true for lenders moving from best effort to mandatory execution. Before making this transition, lenders need to meet certain organizational milestones, including:
- Minimum Net Worth – The threshold for most lenders is the agency standard of $2.5 million, which puts them in a better position to get acceptable dealer lines, approval for mandatory execution with all the investors and have the necessary cash to manage a hedging program.
- Volume – While exceptions can be made based on the types of loans a lender is originating, most will begin to see the maximum benefit with a minimum monthly volume of $10 million in loan closings per month to accommodate effective hedging and bulk commitments.
- Centralized Lock Desk – For lenders using a mandatory execution strategy, gone are the days when a loan officer locks loans directly with investors. Having the ability to create a centralized lock desk if one is not already in place is a must-have when converting to mandatory executions.
Once a lender is ready to move to mandatory executions based on the above criteria, the next step is to understand what specific elements of their current operations that need to change in order to accommodate this shift. One change closely related to the lock desk requirement is to stop locking loans with individual investors. Instead, a hedge advisor should be monitoring incoming loan details via data from the loan origination system throughout the day. This allows the advisor to manage the lender’s position throughout the day and ensure loans are hedged properly as the market moves.
Along these same lines, lenders must prepare themselves to close loans they originate post-transition in their own name. In most cases, loan are sold, and the servicing is transferred before the borrower’s first payment is due. If lenders are supplying their goodbye letter to borrowers within the closing package to notify them as to whom their loan is being sold, that is no longer done in the mandatory execution environment. As a result, both closing procedures and documents need to be adjusted to reflect this new reality.
Furthermore, lenders pursuing a hedging strategy no longer lock themselves into a specific investor’s underwriting guidelines for loans being hedged. Instead, lenders must create and implement their own generic underwriting standards to ensure their loans will appeal to a broader range of purchasers. On a related note, lenders also need to establish their own internal set of guidelines regarding rate lock extensions and loan change requests so loan officers have a clear understanding of what is allowed and can communicate this information accurately to their borrowers.
Regarding technology, lenders engaging in hedging must be sure their LOS possesses the functionality to report on specific data points that impact hedging. Most LOS platforms can provide all hedging-relevant loan activity, such as loan status, rate lock expiration dates, etc., but lenders may not realize this simply because they are not currently utilizing the fields that would allow them to do so. Therefore, most lenders moving to a hedging strategy do not need to switch LOS platforms but instead simply revise their procedures for LOS data entry to ensure the necessary fields are completed for reporting purposes.
As with any change, clear and consistent communication from the top down helps prepare staff for the changes to come and sets the expectation for adoption. With all of the above in mind, lenders should aim for (and easily be able to achieve) a 30-45-day timeline to make the switch from best effort to mandatory execution. During that time, there must the development of a pull-through model specific to the lender’s actual pipeline and submission/approval investors to allow for mandatory delivery as well as open trading lines with broker-dealers.
It is not often that lenders can make changes of this magnitude in such a short order, relatively speaking. Without the proper understanding of what is involved, it can take a lender far longer than a month to make the shift from best effort to mandatory execution. However, lenders who are prepped and ready to make the leap can feel reasonably confident that they will be able to do so quickly and begin maximizing their execution (and profitability) in due course.