TheMReport — News and strategies for the evolving mortgage marketplace.
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24 | Th e M Rep o RT Feature delta hedge strategy allows the mortgage lender to maintain margins and reduce transaction costs and substantial swings in profitability that would otherwise result from trading exclusively with forward TBA securities. Lenders that do not implement an options strategy find them- selves exposed to greater fluctua- tions in both profitability and cash flow. They soon discover that they are constantly adjust- ing their mandatory coverage by selling additional forward TBA securities as prices drop and then buying those same securi- ties back, but at a loss, as prices increase. Without a successful options strategy, bottom-line profitability decreases regardless of the direction of market prices. Experience has shown that over time, the cost of the options contract is less than the expected losses that the lender otherwise would incur. Just like purchasing insurance, the upfront cost of the options limits the firm's down- side exposure and leads to maxi- mum gain on sales at or above the firm's target thresholds. Supplemental Strategies W ith a successful hedg- ing strategy in place, the mortgage lending institution is well positioned to imple- ment additional strategies to further enhance its franchise value, attract and retain quality loan originators, and ultimately achieve incremental increases in target production volume at the required margin thresholds. For example, in a float-down lock, a borrower locks his or her rate but has the option to "float down" or reduce the locked in- terest rate if market interest rates fall during the lock period. An extended lock is an upfront lock for a period in excess of 75 days and frequently used for purchase money buyers looking to protect themselves from rising interest rates during the home shopping process. By definition, long-term locks are susceptible to higher fallout ratios and lenders must hedge accordingly. Lastly, builder commitments represent an option offered by the builder to prospective buyers to deliver a set rate upon completion of a new construc- tion project. Given the different borrower profiles and the terms under which this loan is secured, it also must have a properly designed hedge strategy to match its anticipated performance. It is imperative that pipeline managers recognize that the behavior of a float-down lock will be different from that of an extended lock, which in turn is different from that of a builder commitment. Although each of these features is hedged with option contracts, it is best if they are tracked separately and clearly identified in the pipeline reports to allow their unique behavior patterns to be modeled into the dynamic hedge recommendation. Armed with a disciplined strategy, secondary marketing managers find they can proac- tively manage these additional variables in their pipeline, bring- ing added value to the firm and arming the sales force with addi- tional tools to secure more loans and establish quality relation- ships with builders, Realtors, and other key referral sources. In lieu of implementing a float- down strategy, some lenders feel they are covered by offering a simple rate renegotiation policy. But the truth of the matter is that in either case, the borrower is given the option to obtain a lower rate at some future date. Given that the borrower has the option to choose, the pipeline manager also should protect himself or her- self by utilizing option contracts in lieu of forward TBA trades to protect the pipeline and profit margin from the increased fallout and the associated costs due to declining interest rates. In conclusion, the bottom line is the bottom line. The most successful mortgage lenders, whether they be a mortgage banker, credit union, or deposi- tory institution, employ strate- gies to preserve margins while managing the inherent risks associated with hedging a mort- gage pipeline, including having the right reporting to measure performance and make timely and informed decisions. They follow a daily discipline and the prescribed strategies to achieve their expected results. LOOKING FOR A TRUE PARTNER IN HEDGING? Vice Capital Markets Chris Bennett, CEO cbennett@vicecapitalmarkets.com Troy Baars, President tbaars@vicecapitalmarkets.com 248.869.8100 Vicecapitalmarkets.com How can you make 2013 profits on 2014 production? REPORTING & ANALYTICS CLIENTS • The best fallout work in the industry–bar none. • Daily pull-through model for use in position report custom-built uniquely for each client based upon that client's own historical data, dynamically run daily • Daily Position Report, Mark to Market, and full Shock analysis, also taking into account changes in servicing values relative to market movement • Full FAS 133 and FAS 159 reporting • Consultation and advisement regarding investor, dealer, and agency relationships, contracts, and structures • Daily core base best ex models • Weekly full run-through of newly closed inventory through our detailed best ex programs, taking every loan characteristic into account for all tier-1 and tier-2 trade desk executions • Retained vs. released analysis, and specified pool analysis performed as part of best execution analysis • Assistance with producing daily pricing models, as desired by client, and notification of intraday adverse market moves for use in re-pricing FULL SERVICE CLIENTS–ALL OF THE ABOVE PLUS • All daily and intra-day core position trading and management • Allocation and sale of all hedged newly closed inventory using custom client-driven best execution models, including all AOT paperwork, with all approved top-tier trade desks • FNMA and FHLMC cash sales, and assistance in forming agency specified pools with optimal structures OTHER FEATURES OF THE VICE CAPITAL DIFFERENCE • 12 years of successfully providing full service hedging, through every possible degree of market movement • Work with people who have actually sat in your chair. • We are an active trade desk; you'll never be sent to voicemail when you call. • Only long-term relationships here–no contracts, just agreements, and no upfront costs or set-up fees. We are very selective in which firms we will take on as new accounts to ensure we can continue to provide great service to all of our clients • Any deals or incentives we help negotiate accrue 100% to your benefit–there is no 'split' with Vice, and we do not allow any 'kickback' structures–you can be confident that all execution decisions made were in only your best interest, and not anyone else's • We have the lowest client turnover rate in the industry, at 5% annually, without contracts. Our clients are fiercely loyal for a good reason! Lenders that do not implement an options strategy find themselves exposed to greater fluctuations in both profitability and cash flow. They soon discover that they are constantly adjusting their mandatory coverage by selling additional forward TBA securities as prices drop and then buying those same securities back, but at a loss, as prices increase.