WHITE PAPER - Rate Sheet Behavior

OVERVIEW

Creating rate sheets for originators can be time-consuming and costly, which has prompted many lenders to begin creating their own daily, proprietary rates and pricing. By adopting a nimbler rate sheet approach with custom margin structures, lenders can refine hedging processes, enhance brand perception and better understand profitability – all while saving valuable time.

ARTICLE CONTENTS: Rate Sheet Challenges | Pricing Delay and Market Fluctuation | Act Quickly and Maintain Control With Technology | Contact Us

Rate Sheet Challenges

To compete effectively, lenders need to adopt dynamic rate processes that keep pace with market fluctuations. Without proper technology, many capital markets professionals find themselves running outdated macros and editing complex formulas embedded in aged spreadsheets to produce pricing. In some instances, lenders even leverage spreadsheets built by individuals no longer working at their company, forcing them to navigate a myriad of links and references. Using improper and/or outdated sheets compromises time and accuracy, and ultimately profitability – all to a lender’s detriment.

Other lenders choose to outsource rate sheet creation and distribution processes to third-party vendors. While this eliminates the challenges of maintaining an in-house spreadsheet, the issue of timeliness remains unresolved. Many lenders ask for updated pricing only to wait in a queue behind other requests deemed more urgent by the vendor.

Pricing Delay and Market Fluctuation

Rate sheet lag time is always suboptimal, but it’s significantly easier to manage in the morning than in the afternoon. Intraday holdups generate more risk and increase hedge costs due to the fluctuations of the market throughout the day. The following example examines these effects.

Let’s assume that investor prices move in lockstep with the TBA market (i.e., if the TBA market edges higher by 2/32, so do investor prices). Let’s further assume that when we import TBA prices, our benchmark security is at a price of 102:00. Next, we perform a best-execution analysis of all the eligible investors we would like to include in our rate sheet process. Finally, we back out a profit margin, review our final pricing and publish it.

Though the market was at 102:00 when we published our pricing, it will inevitably fluctuate thereafter. While no one can predict how the market will perform on a given day, we can divide standard movements into three categories:

Originators tend to react differently in each scenario, summarized in the following chart.

SCENARIO	MARKET MOVEMENT	ORIGINATOR REACTION?
MARKET UP	> 0 < 4 32nds	Market is up slightly, proceed locking loans as normal
MARKET UP	> 4 < 8 32nds	Market is up – better pricing might be on the way, hold out for a reprice
MARKET UP	> 8 32nds	Wait to lock loans until secondary republishes rate sheets
MARKET DOWN	> 0 < 4 32nds	Market is down slightly, proceed as normal, perhaps with more urgency
MARKET DOWN	> 4 < 8 32nds	Market is down – it might go lower, lock loans as quickly as possible
MARKET DOWN	> 8 32nds	Secondary reprices – but not before accepting a last-minute lock or two

Behavioral finance teaches us that investors fear losses approximately two to three times more than comparably sized gains, and originators tend to show similar behavior – scrambling to lock loans before a reprice emerges in a sell-off and holding out for higher pricing during a market rally. In these scenarios, the lender’s secondary marketing department pays the price.

Next, let’s use the same assumptions to examine the following scenario with an originator that closes $300 million of hedgeable production each month.

SCENARIO	Move (tics)	Average Price Move (bps)	% of Days	% of Daily Locks	$ Impact	Lock Activity
MARKET UP	<=4	6	30	80	2,454.55	No change in rate sheet normal lock volumes, slight gains, some locks delayed until tomorrow
MARKET UP	4<x<=8	18	15	30	1,380.68	No rate sheet change, too time- consuming, loan officers lock some loans but hold onto most
MARKET UP	>8	37.5	5		-	Rate sheet reissued, after which locks resume
MARKET DOWN	<=4	6	30	100	(3,068.18)	No change in rate sheet normal lock volumes, slight losses
MARKET DOWN	4<x<=8	18	15	100	(4,602.27)	No rate sheet change, too time- consuming, loan officers lock
MARKET DOWN	>8	37.5	5	10	(319.60)	Rate sheet reissued, but not before some locks come in

Each lender will have different coefficients with respect to daily lock volume changes, but the general phenomenon will be the same: lenders will lock more loans (to the loss of their secondary departments) in a sell-off, and they will lock fewer loans (to the gain of their secondary departments) in a rally. While this behavior is largely inevitable, the swing scenarios in the middle present profitability opportunities to lenders.

Act Quickly and Maintain Control With Technology

Lenders that fail to develop and deliver rates and pricing efficiently risk extending an arbitrage opportunity to their originators. Historically, this ends with the lender either shutting down the lock desk to reprice or choosing not to reprice, and accepting the profit and loss impacts with the hope that they even out over time.

However, innovative technology presents a more efficient and profitable alternative to nimbly managing asymmetries in daily lock production, without sacrificing control through a third-party vendor. For example, Black Knight’s CompassPoint^SM Rate Sheet Generator enables lenders to dramatically reduce the time it takes to create rates and prices for their originators, in turn giving secondary teams more reaction time throughout the day. Importantly, these tools allow lenders to create their rate sheets themselves instead of outsourcing this task to a queue.

Furthermore, technology can help lenders identify unrealized hedging costs that compromise profitability – costs that dive deeper than fallout, bid/ask spreads, extension costs and borrower renegotiations. These hidden costs are embedded in daily practices, but unless identified and mitigated, they can be detrimental to bottom lines.