Friday, July 16, 2010

Hedging, Mandatory Delivery and Cash Flows

From the title above I hope correspondent lenders know where I'm going with this post. If you already hedge and deliver loans via mandatory trades or are thinking about taking this step, ask yourself this question: Are you aware, and capable of managing the cash flow constraints this platform may put on your firm?

Bankers active in this space know what I mean as they've been sending some hefty wires in May, June and July.

Here's the concern in a volatile market when mortgage rates drop and the MBS market rallies:

-Volume increases, and therefore so does payroll
-Investors are overwhelmed with volume, slowing turn times for review/purchases
-Approved and Closed loans are "in the money"
-Hedge positions with the broker/dealers are "out of the money"

Large amounts are due to broker/dealers on settlement date and due to sales on payroll. Unfortunately when investor turn time slows, these expenses are incurred prior to the loan sales and can/will put lenders in a precarious position.

I can't stress enough the importance of lenders truly understanding how the changes and volatility in the market effect cash flows for the business. Relying on accrual accounting could be dangerous. Hedging is about reducing risk and exposure--not increasing it!

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