Banks rely on mortgage lending for revenue generation, and to free liquidity for loans, organizations sell mortgages to purchasing agents, something that’s critical to hedge mortgage pipeline management. Hedging a mortgage pipeline involves managing and structuring the pipeline in a way that allows you to reach your profit margin when the interest rate was locked in.
Hedging is complex, but here are guidelines of the process so that you can collaborate with investment advisors.
1. Learn Proper Pipeline Management
Buying a home may not be easy for the borrower, but the loan approval process isn’t always easy for the lender, either. As a result, many institutions and mortgage lenders are given loan commitments that can increase the risk of pipeline depletion. This depletion happens when the borrower locks in a rate that doesn’t account for price fluctuations.
Pipeline management is key to avoiding these risks, and skilled originators know how to implement the right mortgage hedging strategies to reduce and prevent risks associated with fallout.
2. Use Forward Sales Commitments
Forward sales commitments preserve the loan’s value by originating the mortgage with mandatory commitments that state dollar amounts for loans that are guaranteed. If the originator has problems, an agent will charge a fee to pair off the total cost. In addition, forward sale commitments allow you to include additional markup in loan rates that preserve your loan delivery stability.
3. Track the Pipeline
When loans don’t close due to fallout, the pipeline can still be profitable. Those responsible for hedging the pipeline can keep active records of the pipeline and its progress over time. Some ways to track the pipeline include:
- Managing data
- Listing projections for fallout
- Hedge fund advertising
- Calculating mortgage hedge
With proper organization, these individuals can track the pipeline’s progress to see the end results and ensure that everyone is aware of their responsibilities.
4. Be Selective
Hedging can mitigate risk, but the efforts that go into controlling the risk can affect cost preservation. It’s important to partner with firms that have the right experience in capital markets and analysis. With the right hedging strategy, you’ll need experts who understand how to evaluate and project the status of the pipeline.
5. Manage the Pipeline for Secondary Sale
Borrowers lock in mortgage rates when a lender grants them a loan, and the loan then enters the pipeline. Once rates fall, the borrower may choose to work with another lender for a better price. However, lenders can be left with a portfolio of commitments that are at risk of fallout.
6. Hedge Internally
When loan commitments don’t close, a lender can experience pipeline fallout because borrowers aren’t obligated to take a lender’s mortgage. There are significant costs incurred with forward sale commitments, so originators can choose to internally hedge the pipeline to increase profitability instead. Here’s how originators can create a successful internal hedging program:
- Maintain Accurate Data: For accurate models and projections, originators need accurate data and forecasts. Automation can make this easier, but originators must maintain reliable models for monitoring their positions.
- Create Pipeline Stages: Organizations can use fallout ratios to estimate pull-through ratios. These ratios are the likelihood that a loan will be funded. This ratio allows organizations to see how interest rate variations and closing time will affect fallout rates.
- Determine Hedge Dollar Amount: Forward contracts mitigate fallout risk and protect open positions from prie movements. For example, taking short forward contracts on TBA mortgage-backed securities (MBS) can protect originators if the price declines as the hedge position value increases.
A well-organized pipeline management program can decrease the risk of volatility of loans. Internal hedging can offer cost savings, but it relies on the accuracy of an originator’s data and the effectiveness of modeling.
