Mortgage Pipeline Hedging 201

Even though there are a variety of instruments that can be used to hedge mortgage loans, using to-be-announced mortgage-backed securities (referred to as TBAs moving forward) ranks among the most commonly used instruments. TBAs represent commitments to deliver or receive agency mortgage-backed security pools (UMBS), following delivery rules and a settlement calendar established by the Securities Industry and Financial Markets Association (SIFMA), an industry trade group. These commitments are traded in an over-the-counter market, with liquidity provided by both primary and smaller regional broker dealers. TBA markets exist for 30- and 15-year commitments for all three federal mortgage market agencies: Fannie Mae and Freddie Mac in terms of UMBS, and Ginnie Mae in terms of Ginnies (the Government National Mortgage Association). This provides associated fixed-rate hedge coverage that correlates closely to agency conventional and government fixed production.

Over time, secondary marketing personnel may become familiar enough with pipeline dynamics to make educated decisions ahead of potential changes in active hedge volume. They may see an average amount of locks per day, have relatively consistent fallout, or can review expiring locks daily and can foresee when loans will be committed. This gives secondary an advantage to position themselves ahead of those daily happenings.

AOTs, or assignments of trade have been a capital markets staple for years. AOTs provide the opportunity to deliver loans into existing TBA coverage and assign the TBA over to a given investor. The TBA pricing acts as the basis for loan pricing. AOTs reduce hedge costs by avoiding the realization of the bid/ask spread in a typical TBA settlement process. AOTs “draw down” existing hedge coverage and allow for delivery of loans in a shorter time window. This dynamic improves cash flow as the TBA would have settled out in terms of cash at a given settlement date in the future. The AOT allows a lender to deliver loans in a shorter time window allowing for quicker purchase, moving up the cash event associated with purchasing loans that have been assigned.