Fleet Mortgage Group and North American Mortgage Co., two of the largest mortgage banks in the country, are taking very different approaches to hedging.
In speeches this week at a conference on the topic sponsored by the Institute for International Research, executives of the two companies explained different tactics that mortgage servicers can use to tackle interest rate risk.
Falling rates are the worst fear of mortgage servicers-and have become more so in recent years, with new accounting rules affecting servicing portfolios. When rates fall, the value of servicing portfolios also declines, because homeowners prepay their loans. That's why hedging is now common among the larger mortgage servicers.
Steven H. Buisson, vice president of portfolio management for Fleet, based in Columbia, S.C., said it hedges the old-fashioned way: It buys derivatives such as options and swaps that are designed to increase in value when rates fall. Fleet Mortgage has a servicing portfolio over $100 billion.
On the other hand North American, based in Santa Rosa, Calif., uses a so-called production hedge, based on originations.
The idea is that origination and servicing volume should be in the same ballpark. The company made $9.5 billion in loans last year and was servicing $13.3 billion at yearend-a small fraction of Fleet's portfolio, but enough to make it one of the top 50 mortgage servicers.
Gregory Stein, vice president of asset management of North American, said its best hedge against rate risk is to originate loans fast enough to compensate for servicing runoff from prepayments. "We make loans-that's what we do best," he said.
He added that it cost less to originate and then sell off the loans most likely to be prepaid than to retain those loans and buy derivatives to hedge them.
But Fleet's Mr. Buisson maintained that a production hedge isn't sufficient, because accounting rule changes instituted by the Financial Accounting Standards Board in the last two years have forced mortgage bankers to put more of their servicing assets on their balance sheets.
In fact, North American has hinted that it might have to reevaluate its hedging strategy somewhat because of the accounting changes. Senior officials at North American have said it might have to implement a financial hedge if it wants to maintain its current level of servicing. Mr. Stein reaffirmed this at the conference.
And even if North American decided to implement a financial hedge, it would probably want to keep selling much of its servicing. "We currently sell 70% of our mortgage originations," he said. "The reason is there always is someone out there who wants to win a bid."
Larger servicers, especially mortgage companies owned by banks, continue to have an appetite for mortgage servicing, Mr. Stein said.