By Scott Colclough
As lenders and independent mortgage companies aggressively attempt to attract consumers, credit unions must be ever mindful to optimize all competitive advantages they possess. Generally, credit union members are a loyal bunch and want to keep their business in-house. However, as members, they also expect lower fees and competitive rates. One avenue for credit unions with strong mortgage operations to increase profits and, therefore, increase year-end dividends, is by hedging. Though slightly more complex than selling forward commitments to cover customer interest rate risk, hedging locks to then sell shorter delivery-period commitments enables a credit union to achieve better overall execution, which maximizes profitability.
Before a credit union can reap benefits from hedging, they must commit to a modified delivery strategy. Credit unions that manage mortgage operations internally typically sell their production directly to Fannie Mae or Freddie Mac and maintain servicing rights for their members. Often times the commitments used for these sales were taken down in lump sum and filled with loans as they close, which can result in tail pieces causing either over- or under-delivery amounts that need to be paired off. If single loan commitments are used rather than lump sums or if these loans do not close on time – or don’t close at all – extension fees and pair offs may be assessed. While this seems like a fairly innocuous trade-off at first glance, a repeated long-term pattern of this results in thousands of wasted dollars.
When converting to hedging, commitments are not taken out until after loans close, allowing the credit union to use shorter delivery periods that are priced higher and the ability to gain small loan balance pay-ups without fear of loan fallout. Hedging shifts the responsibility for managing rate risk internally, enabling the credit union to take mandatory commitments on a loan after it closes and avoid paying pair-offs on fallout. Not only is this the better way to manage interest rate risk to the credit union, but it also allows the credit union to provide enhanced benefits to its members like the occasional free rate lock extension or rate renegotiation.
Another benefit from hedging for credit unions approved as Fannie Mae and/or Freddie Mac seller-servicers is the ability to pick up additional interest income by holding mortgages a bit longer before selling them. Rather than committing loans as they close, the credit union may decide to hold on to them for a few months and earn the interest rate of the note for an extended period of time. Once that allotted time has been reached, loans are sold into short delivery commitments for the available maximum pricing at that time. By hedging those loans while holding them for a period of time, any market movement experienced is offset by the value of the hedge, giving the credit union the expected margin on the loan sales even though they aren’t completed for a few months.
For credit unions selling mortgages to other non-agency third parties, hedging allows for even greater execution improvement. Again, loans aren’t sold until after they close. Typically, closed loans are packaged together and shown to all of the credit union’s available investors using shorter delivery commitments. With closed loans, investors can offer their best pricing as loan attributes will not change, in addition to the short delivery period.
To begin executing a hedging strategy, certain criteria must be met:
- Minimum net worth – The agency standard is $2.5 million in net worth, which credit unions typically can easily meet. This figure enables credit unions to obtain acceptable dealer lines and garner any investor approvals they would want while having the necessary cash to manage monthly hedging activities.
- Volume – This can be a sticking point for some credit unions. Five million dollars in closed loans per month is a good minimum volume to handle bulk commitments and hedge effectively.
- Centralized lock desk – To utilize a hedging strategy, gone are the days when a loan officer locks loans directly with investors. Having a centralized lock desk if one is not already in place is a must-have when converting to hedging.
As credit unions continually seek to deliver value to their members, maximizing secondary execution via hedging presents credit unions with an opportunity to improve member service by optimizing profitability of their mortgage operations.