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Since the dawn of the Jet Age, passengers can travel farther, faster and cheaper than ever before. The Internet Age promises similar advantages to people financing their homes. But when the mortgage industry builds its version of the Boeing 747 jumbo jet, banks might find themselves booking tickets rather than flying the plane.

Since the dawn of the Jet Age, passengers can travel farther, faster and cheaper than ever before. The Internet Age promises similaradvantages to people financing their homes. But when the mortgage industry builds its version of the Boeing 747 jumbo jet, banks might find themselves booking tickets rather than flying the plane.


"A lot of people expect that transitions that are driven by technology should always be smooth. That's a completely unrealistic view," said Doug Duncan, chief economist at the Mortgage Bankers Association of America. "Technology is always disruptive."

Technological disruptions have the potential to affect every segment of the mortgage industry, both in terms of who's competing and what they're selling. "In the past, companies have been able to differentiate themselves by the level of service that they were able to provide to the customer in actually creating the mortgage," said Duncan. "That advantage is going away-eventually it'll be seamless from the front to the back end."

As a result, the wholesale lenders that enable brokers and loan officers to originate mortgages must fight for relevance in a rapidly changing environment, using technology as a competitive weapon. "In the past we saw a lot of mid-sized mortgage companies, but now we see a lot of smaller mortgage brokers and a lot of mega-banks-Chase, Countrywide, BofA and Wells Fargo-dominating the business," said Scott McAfee, president and CEO of WMC Mortgage, Woodland Hills, Calif.

In The Captain's Seat

The industry participants to watch are Fannie Mae and Freddie Mac. These government-sponsored enterprises (GSEs) are listed companies that purchase, securitize and sell the bulk of conforming mortgages in the United States. In addition to economies of scale, Fannie and Freddie enjoy-as their detractors are quick to point out-exemption from state and local taxes plus an implicit government guarantee against default. "Anyone who's going to play in the mortgage space has to acknowledge the importance of Freddie Mac and Fannie Mae," said Duncan. "They have a very strong interest and a huge investment in technology so they will be a player in one way or another."

As the largest buyers of mortgages, Fannie and Freddie may be in a position to essentially redefine the way that loans are graded and classified. The current process by which loans are securitized and sold to investors sets limits on how loans are priced. Since loans are collected and pooled with other loans of similar credit quality for resale, the industry uses "average pricing." This largely determines the rate offered to a consumer having a credit score in a given range when purchasing a property at a given price. Average pricing helps to make mortgages an easily tradable, liquid commodity. "The primary market is by and large purely competitive-a mortgage is a mortgage is a mortgage in the conventional market," said Duncan. "It's awfully difficult to differentiate yourself."

Loan-level risk-based pricing would change all of that, with potentially dramatic results.

"Customized pricing will come online pretty quickly, where the rates and points charged a particular borrower are easily customized to that property, that borrower and the loan," said Peter Maselli, senior vice president of business development at Freddie Mac. "You'll see the actual loan itself customizing, where the standard 30-year or 15-year fixed product starts taking on different features to accommodate the borrower's preferences, and that gets priced differently."

For example, a teacher without income in the summer months could arrange in advance to forego payments until September. This ability to rearrange cash flows makes the loan more valuable to the borrower and the originator alike. At the same time, holders of those loans can obtain a competitive advantage by basing rates on specific factors that go into a credit score or a property valuation.

Firms with accurate information about properties, credit histories and borrower preferences may enjoy significant advantages over less-informed competitors. "If someone is able to give consumers a more competitive price because they have customized the product or the process, or have a better read on the creditworthiness, you won't get that loan if you're average pricing," said Maselli.

Conversely, firms that continue to use average pricing might misprice loans that should be more expensive. "You'll wind up absorbing more losses than your competitors," Maselli said. "The basis for competition changes-you can't compete the old way any more once you reach a critical mass."

Although customized loans will be more difficult to pool into mortgage-backed securities for resale to investors, the GSEs can jumpstart the market for customized loans by providing the necessary liquidity themselves. "The ability for the secondary market to absorb customized products has dramatically improved," said Maselli. "We've also gotten much better at structuring the kind of securities we sell on the back end."

"Freddie Mac and Fannie Mae both have grown retained portfolios, where we can directly invest in the loans," he added. "The pass-through pools are still an important part of the marketplace, but we're not as reliant on them as we have been in the past."

Fighting To Maintain A Niche

If and when customized loans reach critical mass, banks face the prospect of either retooling their systems to accommodate customized prices and products, or outsourcing processing functions entirely. "Some institutions will look at the way they process loans and decide that it's a source of competitive advantage," said Maselli. "That'll be mostly larger institutions, because processing is a scale business."

Even those banks that just focus on originating loans may have to scramble. "Banks are going to have a lot more competition than they've had before, because even though the mortgage process in a way gets more complex in that it's more customized, to actually do it on the front end of the business simplifies, and that invites many more competitors," said Maselli. "Loan sourcers might outsource a lot of the origination."

"A lot of banks will find value in the ability to retain the customer and cross-sell other products on top of the mortgage," he said. "Banks have a lot to work with because they are trusted financial institutions that many consumers do business with today."

But loan officers at banks face formidable competition from mortgage brokers and their service providers. WMC Mortgage, which prides itself on being an organization with a "nimble" mindset, now exclusively services the mortgage broker market through its WMC Direct portal. "We're giving them the ability to submit a loan, get an approval and get back on the phone with their customer in less time than it would have taken them to get up from their desk and walk over to the copy machine," said WMC's McAfee.

The complexity of a mortgage poses substantial challenges for institutions looking to speed up the process, despite innovations that have drastically reduced the time required for loan approval and underwriting. A legally binding loan package includes a credit and collateral check, title search, insurance and ample documentation, all complying with federal, state and county laws. "Car loans are done in 20 seconds, but the documentation on a car loan fits into a little business envelope," said McAfee. "In California, we're now averaging 210 documents in the mortgage file, and in some places people need to sign well over 100 documents."

WMC's workflow management system permits a relatively speedy turnaround for funding loans. It evaluated a number of leading technology providers before taking the in-house development route. "We're constantly looking for something that would serve our purposes even better," said James Walker, chief information officer at WMC. "But with many of the more general packages, by the time you're done getting them to serve your purposes and still run efficiently, you've ended up developing it yourself."

Mortgage brokers can submit loan data to WMC using loan origination systems such as Point from Calyx Software, Contour and Genesis from Ellie Mae, and Byte TQS from NetUpdate. WMC can accept information from any system adhering to the Fannie Mae export format, a de facto industry standard. Although originally designed for conforming mortgages, the Fannie Mae standard also works adequately for transmitting information about the subprime mortgages that WMC securitizes or sells to investors.

Still, WMC prefers to create deeper links when possible. "The more data, the better," said Walker. "It lets us understand why our loans are performing the way they are, so rather than take the Fannie format, if we can get more data, we take more data."

Other wholesale originators in banking also act as intermediaries for smaller banks' correspondent originators. ABN AMRO Mortgage Group, based in Ann Arbor, Mich., gets approximately 80% of its loan production through its Interfirst Wholesale Mortgage Lending subsidiary. Interfirst communicates with both broker and correspondent originators through its Web site, Mortgages Online At Interfirst, or MOAI.

The remainder of ABN AMRO's origination volume comes through several retail channels, including, the Internet address it acquired last December from the former dot-bomb.

"When they left their space in Florida, we moved in," said William Newman, executive vice president of ABN AMRO Mortgage Group. "We hired a lot of the people that left there, from operations."

MOAI went live in 1998 with the ability for originators to lock a loan and take a price. "It took us about a year to go from zero to 40% acceptance on that," said Newman. "With MOAI, they log on, they can do the rates, test the scenarios, and then decide. When they've committed it comes back to them in seconds with a confirmation."

The acceptance rate of MOAI's online funding and documentation preparation capability was even more dramatic, rising to 90% of total documents requested in its first 14 months. But these initial projects were mostly internal in nature. "We've tackled the parts that we're in direct control of-there's no standardized rate lock mechanism, so we can define our own variables," said Newman. "With things like credit and automated underwriting, you're obviously interfacing with third parties."

ABN AMRO uses Exadel XML-component software from Eltegra, a Concord, Calif. software firm, to connect its back office to its mortgage origination Internet sites.

"Anytime we do a data transfer between different types of systems, Exadel is kind of the glue, or the middleware," said Newman.

Exadel also prepares the bank for integration with outside parties under emerging standards from the Mortgage Industry Standards Maintenance Organization (MISMO), an independent industry body.

"Most back office systems are oriented around the loan," said Randy Friedman, executive vice president of Eltegra. "The MISMO standard is oriented around the customer."

Emerging Standards

While it's an open question as to which entities would benefit the most from their adoption, industrywide XML-based standards have the potential to significantly reduce the cost structure underlying the mortgage process. "It's an extension of the work the mortgage industry has been doing for a decade in electronic data interchange (EDI)," said David Barkley, the elected chair of the 16-member MISMO governance committee and director of e-commerce relations at Freddie Mac. "One of the big things that we're working on with MISMO is a common transaction set for accessing and requesting an underwriting decision from Freddie Mac or Fannie Mae, and now we want to expand to other underwriting systems as well."

Fannie Mae recently agreed to support the development and adoption of MISMO's transparent industry data and transaction standards. MISMO will also address guidelines for electronic mortgages, including standards for document preparation, electronic closing, loan delivery and electronic document vaulting. A sister organization, the Real Estate Finance Security Management Organization (REFSMO), will develop standards for the issuance and use of certificates and digital signatures.

"Fannie Mae has participated since the formation of MISMO and its governance committee, which met for the very first time in January 2000," said Barkley. "But this is the first time they've publicly come out and said, 'Yes, we will use the outcome of the industry efforts.'" Freddie Mac made a similar public announcement in March 2000.

Version 2.0 of the MISMO standard will go even further, adding standards for mortgage servicing and processing data on top of the current standards for underwriting, credit, and mortgage insurance data. "That could reduce the cost of a portfolio transfer from one servicer to another," said Barkley. "The other big area is appraisal and real estate property information, and we're continuing to work on that."

Still, MISMO isn't the first standards organization to have arrived on the scene. "Eight years ago, the Mortgage Electronic Registration System (MERS) was going to standardize the entire industry," said WMC's Walker. "The idea was to hang a giant registration in the sky, to take us away from the paper collateral and go more to an electronic collateral for a loan. At the time, it was never envisioned that we'd all be as independent as we are now."

"We support MISMO, but already there's a balkanization of the XML format," said Walker. "The year before last, XML was the answer to everything. This year, we're finding the gray areas appearing in the XML standards where suddenly you have to know whose standards you're using again."

"We would love to see it get more standardized."


Mortgage Banking Glossary

MBA - Mortgage Bankers Association

MISMO - Mortgage Industry Standards Maintenance Organization

REFSMO - Real Estate Finance Standards Maintenance Organization

FANNIE MAE - Federal National Mortgage Association

FREDDIE MAC - Federal Home Mortgage Corp.

FHA - Federal Housing Administration

BORROWER - One who receives funds in the form of a loan with the obligation of repaying the loan in full with interest.

LENDER - Person or entity that invests in or originates mortgage loans, such as a mortgage banker, credit union, commercial bank, or savings and loan.

ORIGINATOR - A person or entity that solicits builders, brokers, and others to obtain applications for mortgage loans. Often called a loan officer.

MORTGAGE BROKERS - A firm or individual who, for a commission, matches borrowers and lenders. A mortgage broker takes applications and sometimes processes loans, but generally does not use its own funds for closing.

WHOLESALE ORIGINATOR - A firm that purchases loans from mortgage brokers, mortgage bankers or other loan originators.

INVESTOR - Any person or institution that invests in mortgages or mortgage-backed securities.

SECONDARY MARKET - The market where lenders and investors buy and sell existing mortgages or mortgage-backed securities.

Source: MBA Online (

2001 CMP Media LLC. 7/1/01, Issue # 3807, page 22.

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