For many lenders regardless of size, health care costs are expensive. Unfortunately it is about to become worse. The New York Times reports health insurance companies around the country are seeking rate increases of 20% to 40% or more, as new customers under Obamacare turn out to be sicker than projected. Employees can expect companies to take action to further reduce health care offerings as they adjust to the surge in expenses, or to pass along the higher costs. Are we having fun yet? For better news we have some good job news.

Jennifer Fortier, CMB, Senior Associate with the STRATMOR Group addressed the subject of lock extensions, and how/why they cost money:

When a borrower locks a rate with a lender, the lender promises to hold that rate for the borrower until the loan closes. But there is a deadline and moving that deadline back costs money. Depending on what the mortgage rates are doing, this sometimes makes perfect sense to everyone, but other times, it seems counter-intuitive. This is the story behind the 'extension fee.'

The Risk of the Borrower Lock. When a lender takes a rate lock, it takes on risk. The lender grants a lock today on a promise by the borrower to close a loan in the future, say 30 days later.  Between today and the day the loan closes, the market is likely to fluctuate at least a little, and sometimes quite a lot. This leaves uncertainty about whether the lender made a good deal.  Here's a quick example:

On January 1, Mr. Borrower locks a rate of 5%, for which investors of mortgages are willing to pay 100.00*, or par, on that day. This means that the investor will pay dollar for dollar for the mortgage - the investor purchases a $100,000 loan for $100,000. However, on January 30 (the day of closing), mortgage investors have decided they are willing to pay 101.00 ($101,000 for the same loan). In this case, the current mortgage rates advertised are lower than they were at rate lock. The lender now has a loan that it can sell for a premium 1% higher than it thought when it granted the lock. Great for the lender, right? 

At first look, it would seem that if the lender can get more money for the loan, it should be willing to grant a free extension. But if mortgage investors had instead soured on 5% rates, they might pay only 99, or $99,000, leaving the lender with a 1% loss. So, this is turning out to look like a bet and no smart lender is in the business of gambling. So the lender must protect itself from fluctuating markets, called "interest rate risk".

The Hedge against Interest Rate Risk: Lenders mitigate interest rate risk by hedging the locks granted to borrowers.  There are a number of ways to do this, but all work toward the same end result.  Consider that a rate lock is an agreement between lender and borrower - the lender promises to close a loan at a particular rate and in exchange, the borrower agrees to close the loan.  When the lender makes this commitment, it takes on interest rate risk, which it offsets, or hedges, by performing an opposite transaction.

Back to Mr. Borrower's lock . . . when the lender grants a lock of 5% to Mr. Borrower, it does so on the fact that mortgage investors are willing to pay 100 for that rate.  Rather than wait until the closing date and hope that investors are still willing to pay at least that, the lender makes an immediate promise to a mortgage investor to deliver that loan, at that rate, at a future date in exchange for a commitment from the investor to pay 100, regardless of current prices when the loan closes.  The lender and the mortgage investor now have a deal that is essentially tied to the borrower's lock.

The Cost of Time: Investors make decisions on what price they are willing to pay based on risk factors, one of which is time.  Given a preference, investors prefer to make decisions based on known facts, and they prefer to execute their investment immediately.  When an investor promises today to make an investment at some point in the future, (at the date of closing, for example) the state of the market at that future date in unknown, and therefore a risk.  The longer the time the investor agrees to wait for the investment, the more risk he takes, and the more compensation he requires. 

The Extension Fee: On Mr. Borrower's lock . . . the lender received the borrower's commitment to close a 5% mortgage on January 30.  The Lender in turn committed to deliver a 5% mortgage to an investor.  If the borrower requests to close that note 15 days later**, the Lender will not be able to fulfill the commitment to the investor at the same price - the investor wants more money to compensate for the additional risk of time.  This is the extension fee.

What about the Current Market? Note that the current market is not a factor in the extension fee.  Remember that the lender wisely determined that gambling on mortgage rates is not prudent business and hedged the interest rate risk by making an offsetting commitment to an investor.  When the loan actually closes on January 30^th, the commitments from the borrower, the lender, and the investor, are all based on the market the day the lock was granted -- the current market at not a factor at all.

In conclusion, the mortgage investor, and his need to be compensated for the risk of time, is the ultimate driver of the extension fee.

(* The interest rate and market prices are hypothetical only, chosen to make illustration simple.  They do not represent current market prices. ** There are additional factors that contribute to the cost of time for mortgages, such as security pool dates and a lender's ability to make that pool date.  However, for the sake of simplicity, those details are left out of this discussion.  The logic remains the same.) Thanks Jennifer!

Speaking of secondary marketing, John Boyles writes, "Hey Rob-I noticed that there are several ongoing conversations on the LinkedIn message boards about the Best Efforts to Mandatory spread.  Consultants and hedge advisors often tout this spread as one of the major advantages of implementing a Mandatory delivery strategy; however, I find this a rather unexamined approach and believe that it's probably not the best metric to measure success. Plenty of successful mortgage companies have leveraged the best efforts strategy and offered competitive pricing for sales.  A prudent mortgage banker should not be layering risk for a few basis points. In fact Best Efforts delivery is in fact a hedge strategy, and can be rather effective one at that. The fundamental reason to put on risk should be for sake of scale. It's very difficult to scale from $500m to $2b with a B/E delivery strategy as your primary hedge. The more advanced (or risk-on) delivery strategies like AOT, Direct Trade, and even Cash Window and MBS should be entered into in conjunction with a structured and targeted product development revamp. This is not to say you should not put on risk at lower levels, for instance one might want to build expertise and core competencies in key areas such as Operations, loan delivery, secondary marketing and accounting a $50M a month before your firms sales ambition outstrips the execution capability of the firm." Thanks John!

Turning to the immediate markets, Brent Nyitray, Director of Capital Markets at iServe, writes, "If it weren't for the Greek Crisis, everyone would be talking about what is going on in China. Their stock market is collapsing, with the Shanghai Composite B share index down 40% in a month.  The Chinese government has been pulling out all the stops to try and support the market - cutting interest rates, increasing liquidity, creating a stock fund to buy up stocks to support the market - and none of it has been working. The Shanghai Composite B-share index dropped another 9% last night as margin traders get liquidated. To stop the selling, the Chinese government has basically suspended trading in 26% of the stocks on the Chinese exchange. Of course this does nothing but delay the inevitable."

Sure enough, Tuesday the overseas drama continued to overshadow news here (the U.S. trade deficit widened less than expected, JOLTS rose to 5.363M in May from a downwardly revised 5.334M in April, and the $24 billion 3-year note auction was met with soft demand). Greece submitted a 3-year emergency proposal to the Eurogroup Wednesday for a rescue deal in the first step toward getting a new bailout. The package is said to include a short-term funding agreement and a longer-term package. But do the Eurozone finance ministers even want Greece in the bloc?

As I head to SF for the conference there isn't much news in the States. We've had the usual MBA residential application numbers (+4.6%, refis +3% and purchases +7%). This afternoon we'll have the FOMC Minutes for the June 17th meeting, and a $21 billion 10-year note auction (reopening). Tuesday we closed the 10-year at 2.23% and this morning, so far, we're basically unchanged on Treasuries and agency MBS.

Jobs and Announcements

On the retail side, Pacific Union Financial's Distributed Retail Division continues to grow and expand its footprint across the country. The Retail Channel has set new volume records each and every month without exception posting over 200% YTD volume growth and over 800% in the past 12 months with June funded volume in excess of $335M across 37 locations. Bolstering the offering of the Distributed platform is a $17B servicing portfolio alongside a portfolio retention team of 60+ LO's. We are currently seeking a team to join in the mid-Atlantic markets where we offer local fulfillment. Want to make a move and become part of an exciting and productive team? For all the details, please contact Lora Harris, assistant to Brian Mitchell, EVP of the Retail Channel. Or visit www.pacificunionfinancial.com for more career opportunities.

For wholesale, Angel Oak Mortgage Solutions, the top wholesale provider of sub-prime mortgage loans, is expanding! They're looking to hire Account Executives in AZ, CA, DC, LA, MN, OH, OR and TX. They're also hiring Underwriters (with sub-prime experience) and Closers to work out of their Atlanta office. Angel Oak Mortgage Solutions offers non-Agency and specialized mortgage solutions for brokers and mini-correspondent lenders throughout the country. Join the fastest-growing non-prime lender in the nation! Send resumes to careers@angeloakms. com or visit www.angeloakms.com/careers.

And on the operations side, as a result of its' continued growth, PrivatePlus Mortgage/ Private Bank of Buckhead in Atlanta is looking for a Vice President of Operations.  PrivatePlus is a full service mortgage banking company that originates loans in 49 states.  This is an important leadership position within the company and encompasses both strategic and tactical responsibilities over Loan Officer Assistant, Pre-Processing, Processing, Underwriting, Closing, Funding, and Shipping departments.  This is a great opportunity for that well qualified operations expert who wants to lead a fast growing mortgage business.  The pace is fast, the leaders are empowered, and fun is a requirement.  Interested candidates may confidentially respond to Dan Smith, president.

Huh? What? Someone is actually retiring? Well, so it seems that Alex Williams of Crescent Mortgage is calling it quits after giving it a shot in the biz for only 43 years. What the heck? Doesn't he know that the best is yet to come? That rates are going to go back down? That the costly regulatory burden borne by borrowers is going to vanish? Seriously, congratulations Alex on a great career, company, and family. These darned short-timers...