BY EMILY HOLLIS
The two most common forward agreements credit unions use for selling mortgage pipeline loans to a government-sponsored enterprise (GSE), such as Fannie Mae or Freddie Mac, are “best efforts” commitments and “mandatory forward” commitments. Both are valid processes, but there are key differences.
Mortgage pipeline hedging alternatives
A credit union enters into a best efforts commitment when it agrees to the GSE’s mortgage terms on a “best efforts” basis. If the consumer closes the loan, the credit union is required to deliver it to the secondary markets at the agreed upon terms. If the loan doesn’t close, the credit union is not required to deliver and, therefore, experiences no financial loss. Best efforts sales have a place when there is uncertainty about whether a loan will close; however, they are not financially efficient because they result in sizeable mark-up costs to the credit union. The mark up compensates the GSE for taking the risk that the loan may have already been sold to the secondary market and has not been delivered into one of its mortgage pools (a to-be-announced “TBA” security).
Mandatory commitments obligate the credit union to deliver the loan at the agreed-upon terms, including a date of delivery. Risk occurs when the loan does not close, or when the loan closes at different terms than originally agreed.
If the credit union is unable to deliver part or all of its mandatory commitment, the GSEs will calculate a “pair off” fee, which is a fee calculated as a function of both the undelivered portion of the commitment and the corresponding market movement. This can be fairly costly. An alternative to best efforts or mandatory forward commitments for pipeline hedging is using secondary market instruments, such as TBA mortgage-backed securities (MBS).