A risk-management specialist in Florida is offering a hedging program that helps small and midsize mortgage bankers reduce interest-rate risk on loans approved but not yet closed.
Phil Baratz, president of Angus Energy, Fort Lauderdale, said the program also permits smaller lenders to hold onto closed mortgages until they have pools large enough to negotiate better deals with the wholesalers that will eventually buy the loans.
"We found that mortgage-backed securities were less volatile than Treasuries, so the cost of hedging is lower," he said. His strategy is to use out-of-the-money put options on mortgage-backed issues, which become profitable if rates rise.
Tailored to Individual Needs
Mr. Baratz says he tailors the hedge to the exact needs of the lender. "If my client wants to hedge a loan commitment of 45 days, we can have an option that expires in 42 days or 43 days," he said. He buys the options from J. P. Morgan & Co. and Lehman Brothers.
Mr. Baratz pointed out that, by using such hedging, lenders need not lock in rates with their funding sources, thereby saving the cost of the rate guarantee.
The cost of hedging with the put options is about $500 for each $100,000 of mortgages.
Under a worst-case scenario, Mr. Baratz said, interest rates move up just an eighth of a point, not enough to put the option into the money. The options expire worthless and the loan loses some value as well.
The use of put options on mortgage-backed bonds isn't brand new. Countrywide Credit Industries, Pasadena, Calif., uses this strategy for hedging its loan pipeline, according to David Loeb, chairman.
But smaller lenders typically do not have the expertise to manage such hedging programs.