CHAPTER 13 Hedging Interest Rate Risk

OVERVIEW

An integral part of SifiMortgage’s business is its activities in the mortgage secondary market. The bank has the benefit of either originating and holding whole mortgage loans in its portfolio (referred to as the held-for-investment, HFI portfolio), or delivering loans to the secondary market, principally through loan sales to Fannie Mae and Freddie Mac. The primary mortgage market describes the process by which a borrower obtains a mortgage loan from a lender. The lender, in this case SifiMortgage, may find for a number of reasons that selling the loan into the secondary market rather than holding it is a preferred strategy economically.

There are a number of processes SifiMortgage must go through before a loan can be packaged up with other loans and sold to Fannie Mae or Freddie Mac. A borrower first will approach a lender about obtaining a loan commitment from the lender to have a loan at a prearranged interest rate today for settlement of the home sometime in the future. Usually such a commitment ranges from 30 to 90 days in length, during which the lender agrees to “lock in” the interest rate for the borrower. This takes away considerable uncertainty about the direction of interest rates for the borrower while the closing process works its way through, however, it also creates substantial interest rate risk for the lender.

The accumulation of mortgage commitments over time is referred to as the mortgage pipeline. The pipeline ...

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