Pricing to Best Execution

Automated Best Execution Systems May Not be Best

Many mortgage bankers use an automated best execution strategy that incorporates rate sheets and/or Excel models published by a conduit or correspondent investor to price loans on a loan-level basis in order to achieve the highest possible sales price for a loan or pool of loans.

While this sounds like a great idea, there could be significant issues with this approach.

1. Consider the different methods of pricing by investors:

  • Investor “A” prices loans through an Excel model that is linked to an outside data source like Bloomberg and updates the model daily through adjustors and periodically sends out an entire new model.
  • Investor “B” issues indications of where it will buy loans through emailed rate sheets.
  • Investor “C” posts prices on its website and emails rate sheets.
  • Investor “D” prices loans submitted through a file format that prices the loans individually.

2. Those who don’t price according to a formula (like investor “A”), have the ability to price at any time with any amount of improvement or negative price change in response to market conditions or their own volume of activity. They also can change prices for certain coupons without regard to market price changes. So just because the market for 4.0 coupon-based note rates has improved, they have the opportunity to over improve or under improve pricing on any coupon stack or product that they want to buy. Changes are often not uniform.

For example, some investors will change pricing according to a formula; if the market price for the current coupon FNMA 30-year increases or decreases by more than .25 basis points 8-32nds, a new pricing level will be published on a rate sheet or website. This new price level may or may not be in line with the market move for that product and rate, depending on how the investor wants to price at that particular moment. That same company may not post new pricing given a 25-basis point price move but change its pricing on loans it will purchase as soon as the market moves 1 basis point or with no movement at all.

3. Another complication to accurate price discovery is demonstrated by the fact that some investors post a rate sheet as a fixed price until it’s updated, leaving the opportunity to sell after the market has sold off (only if a person can reach the investor in time before the price changes).
Collecting an accurate picture of which investor will give the best execution to a group of loans becomes a very daunting task, even when many staff members are assigned to gather the data simultaneously. Since many automated best execution systems receive data only after investors send out a rate sheet or post pricing to their website (many at different times of the day), each loan being examined for a best execution may be evaluated based on very inaccurate pricing levels even when pricing is scheduled and collected simultaneously.

We at MCM prefer to price loans on a best execution basis using the simultaneous method, wherein pricing data from several known approved investors for the product type being sold are examined simultaneously. This method requires prior knowledge of the investors’ pricing methods and past pricing competitiveness, and the ability to compare pricing and execute quickly. We train clients to use this method and recommend constantly updating the tools used for best execution, so they are ready when the time comes to trade.

And for those using automated methods to gather best-execution pricing to price loans, you may be disappointed when your gains on a sale are severely impacted by using inaccurate methods to calculate the best price available today. Thirty to 60 days later, you may discover that investor wasn’t the best for the loan originally priced.

© MCM 2013