MBS Warroom: DO I LOCK OR FLOAT? by Adam Quinones

Every morning at 6AM I am roused from sleep by an old-fashioned electronic alarm clock. The one that goes 'WAH!' 'WAH!' 'WAH!'. After three rounds of snoozing, I convince myself it's time to get up and head to the office. When I arrive, I unpack my journal and read the notes I took during the previous trading session. Was it a range day or trend day? Who was buying? Why were they buying? What events disrupted the market? What price levels were frequently tested? How far did momentum carry valuations? What were closing marks?

Next I mull over the day ahead. What's on the economic calendar? Who is speaking? What's happening on Capitol Hill? What might move money? How far will it go?

I spend a few minutes chatting with friends on instant messenger. We compare yield spread levels, share current coupon values, discuss prepayment assumptions, and poke fun at each other's home town hockey teams. (Easy for me to say, Alex Ovechkin wears my home team's jersey)

After adequate study, I outline my observations and prepare morning commentary for 20,000 loyal readers (shout out to readers!). In the morning post, which we call MBS OPEN, we communicate our interpretations of the marketplace and provide guidance on the day ahead.

Our objective is to offer insightful analysis and understandable explanations to a growing group of curious mortgage market participants who are seeking answers to their questions. Both consumers and professionals. 

Matt and I do this five times a day. MBS OPEN, MBS MORNING, MBS LUNCH, MBS AFTERNOON, AND MBS CLOSE...with an occasional MBS ALERT mixed in too. As we publish new content, readers comment, ask questions, and often times argue with each other. We reply to comments, pose questions of our own, and occasionally join in on heated debates. We are sociable with the community.

Considering that we publish tailored discussion on the interaction of financial markets and the mortgage-world....it's understandable that we are asked this question quite often:

Here's how our response generally goes:

How big is your pipeline? What are the loan amounts? How many loans are you floating? If you lose rebate is your borrower willing to pay points? Did you promise the borrower a certain rate? If the rate goes up will the DTIs still work? Do you sell direct or broker? If you don't close this loan can you still pay your bills? When are your loans closing?

It's almost an interrogation. You can imagine the reaction of readers. It's something along the lines of: Why so many questions? Why does that matter? I just want to know if I should lock or float!

We usually reply back with our current sentiment and give a pre-recorded market outlook. What's interesting about that situation is, readers come away from those conversations with more clarity about their personal stance despite the fact that we rarely suggest one strategy versus another. Our hope is always that our readers will dig deep enough into what we’re writing that they can formulate their own LOCK or FLOAT decisions. Easy answers are great, but they’re not necessarily the most correct! And based on the “interrogation” mentioned above, one answer is not usually applicable to everyone. 

We know what readers mean when they ask LOCK or FLOAT. To most, it can seem as simple as whether or not we think rates are going higher or lower. But you have to tell us more. Asking the question LOCK or FLOAT without providing the details of your pipeline makes it difficult for us to provide credible guidance. We have no clue whether or not you can afford to lose a deal.

The point is: While we don't mind answering the LOCK/FLOAT question, we encourage readers to participate in the progressive evolution of the mortgage and housing industry. We would rather help you fully understand the REAL factors influencing your LOCK/FLOAT decision. We would rather help you decide on your own strategy. We won't be sitting next to you when a prospective borrower ask YOU the LOCK/FLOAT question...one must be well-prepared and have a well-informed opinion.

I'd prefer not to mention the fact that our industry has been, defamed, denounced, denigrated, and disparaged,...but an angry mob of regulators has formed around us. Isn't in everyone's best interest to put the industry's finest foot forward?

Don't confuse my position with an allegation. I'm not implying the profession is filled with crooks and jokers. If anything it's the total opposite. Those left originating, processing, underwriting, selling, shipping, servicing, or securitizing mortgage loans are likely worth their weight in basis points. After all, if you weren't a productive contributor to the loan process, you were likely a casualty of the crisis. Only the strong survived.

More than anything, by actively communicating and expanding on the events and actions that affect you and your business on a daily basis, we feel that we are adding transparency to the muddled mortgage marketplace. The more we empower YOU, the more we are participating in the revamping of outsider perceptions, and maybe even helping to revitalize the industry in the long run.

While the depths to which we take our audience in analyzing the markets can be fairly intense, we always find a way to break it down PLAIN AND SIMPLE for you. In upcoming issues of the Niche Report, we will provide PLAIN AND SIMPLE explanations of the dynamics of the secondary mortgage markets. Sometimes you will get me, other times you will get Matt, and once in a while you will get both of us.

I leave you with a brief primer on the mortgage-backed securities (MBS) coupons that influence rate sheet rebate.

The MBS coupons that determine your rate sheet pricing are traded in the TBA MBS market...

TBA = To be Announced.

In the TBA MBS market, at the time a trade is made, buyers and sellers agree to a few specific terms like what coupon, the issuing agency (Fannie, Freddie, Ginnie), the size of trade, and a buy/sell price. The actual pools of loans are NOT exchanged when market participants make this commitment.

Instead, the MBS buyer and the seller make an agreement to complete their transaction at a later date. MBS trading settles once a month. In the MBS market this date is pre-determined, it is called SETTLEMENT DATE (clever name huh?).

Two days before the pre-scheduled settlement date, the MBS seller "notifies" the MBS buyer of the specific pools they intend to deliver to satisfy the previously agreed upon terms of trade. The MBS buyer reviews the loan information to ensure the seller is fulfilling the standard requirements of the trade agreement.  Then, two days later on settlement date, funds are wired to the MBS seller and the MBS buyer's account is credited the corresponding mortgage-backed securities.

The TBA trading mechanism plays a very important role in the generation of mortgage rates. The TBA market allows originators to make "forward commitments" before the loans in their pipeline are actually closed...just like loan officers lock in interest rates before the loan goes to closing.

For both the mortgage bank and the loan officer, this function serves as a hedge. It protect their pipelines from interest rate risk (rates getting higher and their loans not being worth as much). If mortgage bankers were forced to lock in their rates after closing...they would likely add in a large "interest rate risk" premium to rate sheets in an effort to protect themselves from shifts in the yield curve.