The recent whipsaw action in rates that hit some players has helped validate the need for proper hedging.
“It validates the need for a disciplined hedging policy throughout the industry,” said Bill Sias, a managing director at MountainView Securities who works in the pipeline hedging area.
Quick and notable swings in rates and yields, such as those recently seen, don’t happen every day but they do happen.
Extreme ones have been seen in 2008, 2003, 1998 and 1987, Sias noted. Volatility such as that seen recently is a far cry from, say, 2008, said Greg Harris, president, MountainView Risk Advisors. But the point is that the possibility of unexpected and significant rate swings has historically been a reality to contend with that could occur at any time.
This remains true even though, when it comes to the extent to which rates affect prepayments —as Harris, who works in the mortgage servicing rights heading area, puts it — things are “not the same as two or three years ago.”
Among other things, in the wake of the recent downturn, the industry’s tight underwriting combined with in some cases depreciated equity levels has limited refinance-driven driven prepayments. This has occurred even as strategic and other forms of default have increased that other type of prepayment.
“We can’t sell or buy futures on [these things in mainstream hedging] but we can look at market factors that indicate the relationship between interest rates and these other factors in aggregate and how they operate on the refinance function,” Harris said.
When it comes to hedging needs on the origination side of the business, such events call for a refocusing “on the data integrity” of one’s pipeline, Sias said.
“You have to have increased focus on the pipeline and examine every particular lock to make sure production is in control of the situation and, if not, the [secondary marketing area] would have to be made aware of it,” he said.
Sias said being disciplined about hedging so that it is done on a constant basis in response to clean and quickly updated data is one of the biggest challenges in his business. Some players tend to get distracted by value of their hedge and want to take off before they should.
If hedges are instead maintained and have good data integrity, “Then you are set up to take advantage of the best prices when you are ready to sell…loans,” he said, noting that this is a key building block for those that seek to move toward becoming an issuer that can retain servicing.
“Those folks that don’t make [enough of an effort to do this], they won’t be here in a few years,” Sias added. “The higher-margin competitors will eventually push out the lower-margin competitors.”