Hot Fallout – Crazy Price Change Matrix

Unicorn Zone – With fallout this low and unchanging, hedging with options would be unnecessary. With over 92% of all locked loans closing, the fluctuations in pricing and fallout would not be great enough to warrant hedging with options. This is the unicorn zone! Something is too good to be true, or somebody is not giving you the whole story.

No Go Zone – As the name suggests, this area is to be avoided. With fallout and fallout volatility levels this high, profitability would be erratic and unlikely given the amount and cost of options needed to properly hedge such a pipeline. In the no-go zone, policies and procedures would need to be evaluated to better understand the sources or causes of such high fallout and volatility.

Too Sensitive Zone – This zone is getting closer to something that a hedge advisor could work with. In this zone, the mortgage pipeline is too sensitive to price changes. On the chart above, as the price of the mortgage-backed security begins to increase, the fallout percentage ramps up too quickly. This pipeline can be great given the correct market conditions, but as things go south, profits can erode too quickly and leave the mortgage pipeline at too much risk.

Normal Fallout Zone – This area represents where most mortgage bank’s fallout and fallout sensitivity lie. In this zone, the pipeline demonstrates some degree of price sensitivity, but it also has borrowers that are relatively inelastic to price changes. This allows for the efficient use of options-based hedge coverage in conjunction with TBAs with the correct amount to react to price movements at a reasonable cost while still having some degree of certainty when it comes to loans closing and ultimately profits.

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