Production MBS Close at Session Lows. 3.50s Carry the Most Interest Rate Risk
After a slow overnight session that left rates better bid heading into the domestic trading day, benchmark TSY yields and rate sheet influential MBS prices ended up losing all positive progress before closing at their weakest levels of the session.
The December delivery FNCL 3.5 traded as high as 101-06 before going out -0-05 at 100-22. That is a 16/32 price drop. This decline definitely warranted reprices for the worse, which were reported.
Since Friday morning, rebate has been reduced by 40bps on average, but week over week loan pricing is still better by 37.2bps....
I did hear that retail pricing was essentially moved out of the market, let me know if you heard/saw the same thing. This would imply that the major store front lenders/big call center bank shops filled their quota last week and are now adjusting pricing to slow production. This aligns well with what I am seeing in my model...after tightening up primary/secondary loan pricing spreads on Friday morning, lenders added some juice to rate sheets today. See the ΔBE v M column. That is the spread between BEST EFFORTS delivery pricing and MANDATORY delivery pricing. That basically represents the difference between the mortgage rate pricing and MBS prices. RED means more margin. All of the majors added margin today, erasing the improvements we witnessed on Friday.
EXPLANATION OF LOAN PRICING COMPARISON
Buydowns are the cost of floating down to the next lowest note rate. Buydown costs are matched to the note rate in the same row. For example, the first number in the buydown column is .352%, this is the cost to float down from 5.00% to 4.875%, as a percentage of the loan amount. This is important because it helps an originator determine the best execution rate/points combination for a borrower who has a good idea of how long they intend to live in their home (breakeven on points paid vs. monthly payment savings). In the Buydown Delta column, red is cheaper. Black is more expensive.
The pricing change column is a direct rebate comparison of pricing today vs. pricing yesterday. Red is worse. Black is better.
The BE v M column shows you how margin is changing. RED means more margin. Black means less bps are baked into pricing.
I do not show the actual price lenders are paying for loans. This is too much info. I would get angry emails from lock desks and production managers. I will tell you this though, the comparison is based on raw pricing. There isn't another markup built into my model.
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When thinking about managing risk from an originator's point of view, we can never say enough about the importance of being prepared. If you can't discuss what's moving mortgage rates, you can't identify and evaluate your potential risks. You never want your guidance to become a guessing game. This is a lot of responsibility for one person to handle, but if you are able to identify and explain potential risks to your clients, you won't be alone in the decision making process. You transfer risk off your personal P&L.
There are multiple ways in which interest rate risk can affect your pipeline. There are day over day rebate improvements that might not justify a reduction in the note rate offered and only add to the originators bottom line. The opposite can occur just as easily though, especially when you narrow down your lock/float horizon to a day over day decision. But when it comes down to it Lock/Float isn't that black and white. There are many more considerations to account for...
For example, how sensitive is your borrower's DTI to a shift in loan pricing? Can afford to lose the deal if rate goes higher? Is your lender increasing their turn times? Has your lender been more aggressive than other lenders? Are you anticipating a long list of stipulations?
Also, let's say you're floating a note rate priced close to par. Did you know that note rates priced close to par are generally the most vulnerable to rebate reductions? What note rates carry the most duration? Is the note rate you've quoted one of these rates?
What is duration?
Duration is the sensitivity of a bond's price value to a change in interest rates. What duration tells us is how much a bond's price will change based on a given change in yield. An originator might view duration as the sensitivity of their loan pricing to changes in MBS yields or benchmark yields.
Plain and Simple: Duration is just a really fancy word for interest rate risk
At the moment, note rates used to fill 3.5 coupon delivery buckets are the most sensitive to rising rates in the long end of the yield curve. These note rates include: 4.25%, 4.125%, 4.00%, 3.875%, and 3.75%.