Understanding the Blackbox of Margin Preservation
When rates go up, the value of the pipeline and warehouse goes down. The reason there is a decline in value is that the future cash flow is discounted at a higher interest rate, based on the current market rate, which results in a lower present value... blah, blah, blah.
To protect from interest rate risk, mortgage lenders may receive a "Best Efforts" forward purchase commitment from an investor.
An alternative to a Best Efforts lock commitment is to use the mortgage-backed security (MBS) market to hold the future gain on sale steady until the loan can be sold. This is accomplished by selling a future MBS before it is created. By selling this forward commitment, the price change is opposite compared to the IRLC or LHFS. This "sold" or "short" position's value goes up when rates go up and is designed to hold the value until the loan is sold. Once the loan is closed, a short-term mandatory commitment is received and the short MBS position is removed through a pair-off transaction.
One complicating factor is that the short position is a pool of various MBS forward commitments into which many mortgage loans may be delivered. This means that there is no loan to hedge relationship. The same short position may be used to hedge lots of loans. It is possible for a new lock and a loan sale to occur on the same day in which case the short position is not changed, even though two or more loans are "hedged" by the same MBS short position. This means there is no one-to-one relationship between a loan and the MBS short position. Tracking the gain on sale is presented by the hedge advisor reports.
To launch hedging, it is essential to have a hedge advisor, a qualified secondary manager, and a single, unified lock desk. See blog post on launching a hedge position by clicking HERE.
See the blog post "CFO's Guide to Hedging" for more information by clicking HERE.
Also see the blog post "10 Steps to Launch Hedging" by clicking HERE.
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Dr. Andy Schell, DBA (Ph.D.), MSML, MBA, CPA/CFF, CMB
Dr. Schell is CEO, Managing Partner, and Co-Founder of Mortgage Banking Solutions and MBS Financial Services ("MBS"), based in Austin, Texas. Dr. Schell is known for his ability to turn "vision into reality" and "chaos into order" as he finds creative solutions to the challenges his clients face addressing Revenue Stability, Technology Enhancement, Financial Management, and Workflow Efficiency.
He has 4 decades of experience as a strategist directing the activity of both small and large groups of employees including mortgage lending activity at Bank of America. His leadership knowledge extends from his hands-on experience and his doctoral academic pursuits in communication, strategy, and finance.
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