By Troy Baars
Digital is today’s mortgage lending watchword. Stem to stern, every aspect of the mortgage process has felt either a direct or ripple effect of an intense, industry-wide focus on automation, including its most esoteric element: hedging. However, even as the benefits of going digital in origination, closing and servicing are fairly clear cut for consumers and internal players alike, the same cannot be said of hedging.
Further, the ways in which hedging can be improved by a digital process are more often than not presumed versus proven by standard industry practice. That’s why lenders plotting their enterprise digital strategy must proceed with a clear vision for what is and is not possible in automating hedging.
Among its digital mortgage assumptions, the industry tends to expect that hedging will be contoured by increased investor demand and preference for digitally executed loans. This assumption is rooted in a belief that loans originated digitally from application through closing utilizing direct-source data for verifications are “cleaner” than those executed via traditional means — which is true. Further, engaging a digital process in the processing and underwriting phases of origination also enables lenders to access better data faster, allowing for detection of real-time changes that affect ability to repay, such as changes in income and/or debt ratios.
From here, the thinking goes that absent compliance, underwriting and/or execution errors, investors feel more confident in modeling the performance of these loans and will be willing to pay a premium for that certainty.
However, industry veterans of multiple cycles know all too well what can happen when we assume. So it goes, that while there may be one-off investors currently telegraphing this desire to their lender clients, there is no current market indication that this confidence is driving widespread demand among the broader investor pool. Of course, the low overall volume of e-notes, most of which are sold directly to Fannie Mae, may be the primary reason this is true. Regardless the “why,” the fact remains that there is not currently a greater demand or an available pay-up from investors for digital mortgages.
Lenders’ second major assumption about automation and hedging is that the hedging function can be automated completely. Although there are tools that can help lenders manage their position and track market direction, it would be, practically speaking, impossible to account for all the variables that comprise an overarching hedging strategy in a way that truly maximizes a lender’s execution via a single piece of technology.
For example, most hedging-related automation is calibrated to help lenders manage a straightforward mandatory execution strategy, in most cases a better option versus best effort. However, custom or specified pools offer lenders the opportunity to capitalize financially on investor demand for specific types of loans at a specific time.
Uncovering these opportunities requires building strong relationships within the dealer community so that, as market conditions change, lenders can anticipate what types of loans may become in demand and respond accordingly. Given that investor pay-ups for specified pools can fall anywhere between 25 to more than 600 basis points, there is tremendous potential for lenders to capture even more profit from their hedging activities.
However, pursuing an “automation only” strategy, lenders would be leaving this potential profit on the table because today’s hedging platforms simply aren’t capable of managing specified pools.
This is not to say that lenders should not apply automation to their secondary market activities. On the contrary, there is much to be gained from the strategic application of automation in the secondary department, such as taking five-day commitments to the agencies down to just two. However, the key word here is “strategic.” As with any change, lenders must be thoughtful in what aspects of their processes they choose to automate and be crystal clear on the proven value these changes will bring to their organization.
The goal of a digital mortgage strategy should not be to completely eliminate the human element from the process. Instead, the focus should be on driving efficiency, increasing profitability, reducing errors and delivering a stellar borrower experience. If applying automation to a particular process, especially hedging, does not meet these standards, lenders would be wise to shift their automation efforts elsewhere to maximize the execution of their digital mortgage strategy.