Finally, Wall Street appears poised to go electronic with mortgage securitization.
In recent years those involved in mortgage origination have pushed hard to create what until now has seemed impossible: the one-week mortgage (American Banker, Nov. 29). Secondary market buyers such as Fannie Mae and Freddie Mac, lenders such as Countrywide Credit Industries, and Internet companies like Mortgage.com, are working to make every piece of the origination business, from appraisal to tax filing, accessible within minutes.
But the investment banks that securitize mortgages have lagged behind. Today, as Wall Street banks get pools of loans to securitize, they still manually review each loan or file in a process called "post-bid due diligence," often with the help of third-party providers. Few if any investment banks seem to be interested in automating the process.
"There hasn't been a huge effort in the bond world to go electronic, whether you're talking about the securitization process or even trading," said Richard Beidl, senior analyst at Tower Group, a consulting company in Newton, Mass. "With bonds you're talking about institutional sales, whereas the equity world is much more focused on the consumer. That's where electronic efforts have been concentrated to date."
Said another executive: "This is like teaching an old dog new tricks. Technology advances have not been made consistently in the mortgage business, and these guys are struggling to drag themselves into the millennium."
Now, though, software companies such as Austin, Tex.-based Arc Systems.com, which specializes in automated underwriting solutions for the subprime lending community, are pushing Wall Street to automate securitizations. Those reportedly focusing on the issue include Bear, Stearns & Co. and Goldman Sachs Group.
"The amount of manpower needed to review each of these loans manually is cost-prohibitive," argued Ed Jones, chief executive officer at Arc Systems.com. "The whole objective is to reduce the cost to the consumer. If Wall Street didn't have to do the manual underwriting, you'd no longer have to charge back that expensive cost to the lender. Ultimately, the lender would be more competitive, and the consumer would reap the benefits."
Executives like Mr. Jones maintain that if Wall Street would tie in directly to automated underwriting systems like theirs, it would no longer need to review each loan; instead, a sampling of loans could be reviewed before securitization proceeds and the resulting bonds are rated. "If we can build up an electronic loan profile here that includes credit and application information, that can be used directly by Wall Street as it configures the securitization," he says. "There's no question that you would have a speedier, more efficient, and cost-effective process."
The Wall Street firms understand that they need to join in industrywide efforts to eliminate paper. "We believe that the mortgage process will continue to make a lot of progress in the next several years with its streamlining efforts," says Kenneth A. Posner, a principal at Morgan Stanley Dean Witter in New York, "the result being that the whole cost structure could fall by half or more. Securitization will be part of this, the biggest change being going from paper to electronic files. At the moment, though, Fannie and Freddie are still the biggest securitizers, and they still require paper files."
James M. Marks, an analyst at Credit Suisse First Boston in New York, said he believes the origination business will evolve so that the mortgage banker eventually is cut out entirely.
"We're only in the first generation of mortgage origination automation," he says. "Now, a consumer can access a data base, a list of product offerings, submit an application to the lender. The consumer is essentially ranking lenders on price, submitting applications accordingly."
The next phase, he says, will be creating a bid/auction market where applications are submitted simultaneously to all lenders. Then, he says, "the smarter lenders will start to micromanage applications, providing pricing on a one-on-one basis, reflecting the fact that every credit profile should have a price to it. Today you still have a system where people fall into fairly broad buckets of ratings, say those in the 'A-minus' range."
With a bid/auction market and one-on-one pricing, the mortgage banker will become irrelevant to securitizations, Mr. Marks says. "Once you get into this kind of bidding and pricing, there will be a much stronger correlation between credit scores and rates. Taking this into the securitization process, the ultimate holders of the mortgages will become the bidders on these electronic systems. In the process you eliminate the mortgage banker, who in the past has added value by aggregating all these loans into pools. You will no longer need to pool, in effect. So we're reaching the point where the investor links more directly with the originator of the paper, creating their own pools."
Mr. Marks is not alone in believing that the process leading to origination will change fundamentally.
"One of the next steps you're going to see is ratings provided for loans at the point of sale," predicts Mary L. Tipps, Arc Systems.com's marketing director. "We'll have the ratings agency guidelines incorporated into our system, so the loan will be rated before it's originated. It will help the lenders from a competitive standpoint because the lender will be able to better manipulate the price charged for the loan at the POS.
"It's pie-in-the-sky at the moment, a longer-term evolution, but it will happen." Mr. Quinn is a freelance writer in Arlington, Va .