Fleet, PNC, Mellon, Homeside Lending. the list of banks selling off their mortgage units keeps growing. Its a cycle that we go through, says Richard Beidl, a Norwood, MA-based independent mortgage analyst. Banks jump in and out of the refinancing business because they cant make money when rates are low.
There are plenty of tools to lower credit risk by helping banks weed out borrowers likely to default, but with fewer than 2 percent of loans expected to default this year and interest rates dipping to around six percent, lenders stand to lose far more from refinancing than they do from default. Aside from prepayment models which provide broad averages on expected rates of refinancing, the tools available to help lenders
determine which customers are most likely to shop around for new loans are, say industry experts, crude and limited. With projections from the Mortgage Bankers Association of America (MBA) placing 2002 loan originations at $2.4 trillion, with $1.4 trillion from refinancing, a few vendors are racing to fill the prepayment tool shed. Applied Financial Technology (AFT) of San Francisco plans to release its new Espiel prepayment score next month. And word is San Francisco-based LoanPerformance is close behind with its own prepayment score. I dont know how long Ive seen news stories saying this is the next big thing in mortgage banking, says Arden Hall, evp at San Francisco-based Wells Fargo & Co. I think [the delay has] been a lack of a real viable product.
Mortgage lenders and analysts support the idea of an effective prepayment tool that would assign numbers to individual borrowers based on their propensity to refinance, but theyre cautious in their optimism. Revolutions are slow to come in the mortgage industry, says Doug Duncan, svp and chief economist at the MBA. But certainly, it could change things.
If not a revolution, prepayment scores could be one of the legs supporting an industrywide shift toward risk-based pricing, says prepayment consultant Richard Harmon, a consultant whos worked on prepayment models for banks and vendors. Just as borrowers are given rates based on their risk of default, lenders could price mortgages based on borrowers risk of refinance, potential to buy more products and services and other factors that indicate a customers overall value, says Harmon. By combining customer relationship management tools with risk-based pricing, lenders can provide individualized service to each borrower. But, he adds, such a shift wont come easy.
AFT CEO Michael Bykhovsky says there are about 20 characteristics that help determine a borrowers prepayment scoreitems including loan size, primary or secondary residence, whether the last refinance was a cash out, multi- or single-family home, income level, geography, channel of origination, number of children, previous prepayment history.
The score provides a more granular layer of information than prepayment models such as those offered by AFT, Andrew Davidson & Co., Black Rock Financial and others, says Bykhovsky.
Prepayment models, for instance, can forecast that a certain percentage of borrowers with eight percent loans will refinance if rates fall to seven percent. That helps investors balance their loan portfolios over the long term. Prepayment scores, however, go a step further by indicating which of those people are likely to refinance. That can help lenders in the short term because they can pitch those customers lower rates before they go to rivals.
Bykhovsky says AFTs prepayment score, which is in beta testing with three banks that asked not to be named, will offer both long-term and short-term scores. The score is scheduled for release by early next month, and while Bykhovsky says he hasnt finalized pricing yet, the long-term scores will initially be available for free, and the short-term scores and hedging differential tables will be available with a subscription fee. Customers will be able to access the score through an FTP site or they can use AFTs Dynamic Aggregator, which will analyze an institutions portfolio of loans.
Hall doesnt work with prepayment models at Wells Fargo, but hes spent years helping develop them at Charlotte, NC-based Bank of America Corp. and Fair Isaac & Co. of San Rafael, CA, and he believes they have great potential to help banks retain customers over the short term. That said, he has reservations about the claims by vendors that they can determine borrowers propensity to refinance at origination.
When borrowers look for a mortgage, they shop around for the best rates, so it would be hard for banks to raise rates based on their scores, says Hall. And while a score can tell lenders something about a borrower, peoples circumstances change as drastically as the economy and interest rates, he says, adding that interest-rates are the biggest determinants of refinance activity.
Beidl is equally skeptical. Its harder to factor loan runoff when youre at the point of origination, he says. If I ask you what interest rates will be like in six months, how can you know that? Its pure speculation at best.
Even if the scores were a foolproof predictor, they can be useless if banks dont have the resources to act on the information they provide, adds Hall. For instance, the score might determine that hundreds of customers are likely to refinance, but if the bank doesnt have the staff, services and products to entice them to stay, that information wont do any good, he says. This is essential, but its not some panacea, says Hall.
MBA economist Duncan warns that the biggest problem with prepayment scores is a political one: lenders want to identify people interested in refinancing to retain them as customers, but investors want to keep refinancing to a minimum.
Still, the prepayment score can be helpful as interest rates continue to drop, says Aaron McPherson, a lending industry analyst at International Data Corp. (IDC) in Framingham, MA. The question is, Whats the shelf life for this? asks McPherson. As rates start to go up, theres not going to be a lot of refinancing.
