Top 5 Pipeline Management Mistakes
Made Since the Election
- Bad Hedge Ratios: Using Regression based or linear Duration Based hedge ratios. In some cases, the regression approach resulted in an average loss attributable to incorrect hedge ratios after the large down price movement of approximately 3 points after the election. For example, if $100 million of FNMA 3.5 coupon based loan product was hedged with FNMA 3.0 coupon TBA’s (using the before election regression based hedge ratios) a loss of 45 basis points or $450,000 would have been incurred and will soon be realized given the 3 point drop in the market and a 15% error in hedge ratio.
- Static Fallout Estimates: Employing an inaccurate Fallout model or using static fallout assumptions during the period. For example, if your pre-election fallout model used a fallout rate of 25% and continued through the 3 point change in the market and your average actual fallout went down to 15% during the period, your expected loss due to inaccurate fallout assumptions would total $300,000 based on the 10 percent under hedged pipeline.
- No Option Coverage: Not using options to hedge the expanded exposure to the pipeline due to decreased fallout. For example, when the market has large moves downward – something that has not happened for a long time, more loans closed than usual because borrowers are more motivated to provide documentation and get the rate they locked in. Also, they have a harder time finding a lower rate somewhere else. The increased exposure from higher closing rates and market volatility would have also increased pipeline hedging costs. Both of which need to be accounted for by employing the correct amount of Put option coverage. In the future, increased volatility will cause losses for those not using put options by having the tail wag the dog and being whipsawed from pairing out and selling after adverse market movements.
- Old Pricing Levels: Pricing loans based on old or in some cases less than updated pricing for new locks. Many firms use best efforts based pricing in their automated loan pricing systems. These pricing levels are meant to be indications of where an investor would purchase the loans at the time they are posted. Not a guarantee that they will in the future. In many cases over the last month these levels were old at the time locks were taken – in many cases by a significant amount because the market had deteriorated and the best efforts based prices had not been updated.
- Underestimating Locks: Taking locks after the market had closed for the day and not anticipating the volume of loans that needed to be covered before the market closed for the day. In a market that gaped down many times at opening i.e., before trades could be put on for the day additional losses would have been incurred. For example, if the amount of new locks anticipated from overnight locks was $5 million on a given day and turned out to total $10 million and the market sold off a point before the market opened for the day a loss of $50,000 will eventually be recognized.
© 2016 Mortgage Capital Management, Inc.