We know that interest rate lock commitments (IRLC) fallout for reasons ranging from credit declination to finding a better rate with another lender. We also know that under a ‘if rates fall and prices rise’ scenario and we have placed a forward commitment (i.e. hedged the IRLC) to deliver that loan and the IRLC falls out, we will suffer a pair-off loss. Conversely, if no hedge is placed and interest rates rise and the IRLC does not fallout, we will suffer a loss when we eventually do commit the loan to an investor.
Having a strong handle on the tendency of an IRLC to fallout or not, is vital to secondary marketing competitiveness and profitability.
Traditional approaches have progressed over time and practice:
A first-generation approach to formulating a closing ratio (closing probability factor) is to look at a batch of loans processed during a period of time, then calculate the number of files that closed and divide this number of closed files by the total number processed.
A second-generation approach makes sub-calculations based on channel and/or purpose and/or underwriting milestone achieved of the IRLC.
A third-generation approach formulates a mathematical fallout tendency function that would return a fallout incentive option value. The by-product would be a fallout probability (delta) factor.
A fourth-generation approach would run correlation curves based on the characteristics of the loan, the nature of the fallout event and the path interest rates have taken.
A fifth-generation advances the correlation to consider strength of sample sizes and consistency of observations over staggered time frames and production volume levels.
Each generation has placed the executive in a better position than if they did no factoring.
However, a sixth generation analysis that we now offer draws from fifth generation insight and allows users to compare and contrast the performance of existing and candidate closing ratio curves (i.e. grids) in terms of hedging profit or loss for specific market scenarios and/or balanced across mortgage market scenarios.
The end result of this transparency is a perpetual process of implementing closing ratio curves that systematically reduce hedging costs and elevate hedging benefits. In other words, the secondary marketing management team experiences reduced negative earnings volatility from hedging activities, while preserving more upside potential from secondary marketing pipeline management. |
