By John Baity

This past September, the Federal Home Loan Bank of Boston (the Bank) hosted a secondary market seminar. The featured speaker was Pete Taglia of FTN Financial Capital Assets Corporation, a well-regarded mortgage banker who consults with financial institutions nationwide.

In his opening remarks, Mr. Taglia suggested that attendees take a fresh look at their secondary market practices and embrace competition when it comes to selling their mortgage loans. Mr. Taglia emphasized that "seller/servicers want as many outlets as possible like the Federal Home Loan Bank of Boston to compete for their business." He pointed to a trend for banks and credit unions to have more rather than fewer investors competing for their mortgage business.

That competition could not arrive at a better time. With the expectation of a cooling housing market and reduced refinance activity, the market weakness that some members are now experiencing may continue in 2006. As a result, now is an ideal time for members to consider measures to improve profitability and stave off sources of competition that may be eroding their market share.

Most seller/servicers that participate in our Mortgage Partnership Finance Program® (MPF®) claim that a major reason for doing so is to achieve better price execution on the sale of their conforming 15- and 30-year fixed-rate loans. Many of these members have a "two-investor" business model that allows them to choose between selling to the Bank or another outlet (for example, Fannie Mae or Freddie Mac). They sell to the investor that offers them the "best execution."

To facilitate a best-execution pricing comparison, staff at the Bank have developed a simple Excel-based Best Execution Analysis model. By utilizing this model, members can identify the most profitable bid for their fixed-rate mortgage (MPF-eligible) business to improve their profitability and lower their lending rate in the marketplace.

Before explaining how this model works, it is useful to highlight some basic reasons for using the Best Execution Analysis model:

• It's prudent to check pricing. While MPF should offer superior pricing versus investors that have guarantee-fee based secondary market programs, pricing can and does fluctuate due to market changes or other factors.

• It's fast and easy. It takes only a minute for secondary market managers to input the assumptions required to do the price comparison (see Exhibit 1). The model then, via access to the eMPF web site, performs an automated lookup of the MPF pricing sheet to obtain the relevant MPF price.

• It reduces error. Because a model is doing the price look-up, it eliminates potential human error due to factors such as looking up the wrong price-rate sheet, not making the proper adjustment for calendar versus business days (MPF uses business days), or eliminating other cash flows pertinent to value calculation for MPF or the other investor (for example, MPF pays a credit enhancement fee).

• It documents value. Secondary market managers create value when they achieve a better price on loan sales. By running and saving the Best Execution Analysis model, the secondary market manager can document that value. By analogy, a chief financial officer (CFO) selling an investment security records price bids received from competing brokers to demonstrate that the best price has been achieved.

Using The Best Execution Analysis Model
As the accompanying Exhibit 1 shows, the secondary market manager runs the Best Execution Analysis model by entering basic loan-level data and delivery information in the prompted fields, including dollar amount, coupon, and date of expiration of delivery commitment. This takes very little time. Other inputs required to do the "all-in" pricing calculation — such as the value of the credit enhancement fee or estimated loss exposure, if any, on the credit enhancement obligation — are not necessary to calculate the current MPF price. The member's CFO or asset-liability committee would normally set those assumptions in advance of the daily pricing computation.

It should be noted that the Best Execution Analysis model is not a projection of accounting earnings but rather a projection of economic value that incorporates all relevant cash flow differences between MPF and a member's other investor. Its purpose is to help the member make an economic evaluation in regard to the sale of MPF-eligible, fixed-rate mortgage products.

Summary
If your institution is not already using a best execution model, you may want to consider using the Best Execution Analysis to improve your secondary market execution in 2006. Our MPF secondary market sales managers — Bill Dolan and Mark Sullivan — would be happy to explain how to use the model.

Below is a snapshot of information input by the member into the model to obtain the current pricing. Input information is for illustration purposes only. Your institution will need to update with all applicable information for MPF and your alternative investor.

Below is the summary of the best execution. Again, this is for illustration purposes only. Actual information depends on the member completing all relevant fields.

For more information about the Bank's MPF program, please call 888-675-0556, or call Mark Sullivan at 617-292-9672, William Dolan at 617-292-9691, or Paul Pouliot at 617-292-9641.

"Mortgage Partnership Finance" and "MPF" are registered trademarks of the Federal Home Loan Bank of Chicago.

John Baity is vice president/relationship manager for northern New England at the Federal Home Loan Bank of Boston.