What Is a Mortgage Pipeline?
A mortgage pipeline refers to mortgage loans that are locked-in with a mortgage originator by borrowers, mortgage brokers, or other lenders. A loan stays in an originator's pipeline from the time it is locked until it falls out, is sold into the secondary mortgage market, or is put into the originator's loan portfolio. Mortgages in the pipeline are hedged against interest-rate movements.
- A mortgage pipeline is the backlog of mortgage applications that are still waiting to be approved, but which have interest rate locks.
- Since rates are locked, fluctuations in prevailing rates during the period between application and loan approval exposes banks to interest rate risk.
- Scrutinizing mortgage pipelines can help analysts understand future homeowner borrowing.
Understanding Mortgage Pipelines
A mortgage originator is generally the first entity that's involved in the secondary mortgage market. They can range from retail banks, brokers, and mortgage bankers. The mortgage originator's pipeline is managed by its secondary marketing department. As noted above, the pipeline consists of mortgage applications that have a locked-in interest rate but aren't yet approved.
The loans in the pipeline are typically hedged using the "To Be Announced" market—or the forward mortgage-backed security pass-through market—futures contracts, and over-the-counter mortgage options. Hedging a mortgage pipeline involves spread and fallout risk.
There is a risk of spread and fallout by hedging a mortgage pipeline.
Mortgage pipelines are usually managed and structured in such a way to realize the profit margin that was ingrained in the mortgage when the interest rate was locked in. A mortgage pipeline can directly affect the income of a mortgage broker, who may be paid on commission that is based on the lucrativeness of the deals they broker. Mortgage brokers may aim to build up their pipelines by developing referral networks that can include real estate agents, bankers, attorneys, and accountants who can direct new clients their way.
There is an assumption, though, that at least some of the potential loans in a mortgage pipeline will not be funded and become mortgages that can be sold. The farther along the application process is, the less likely the borrower will seek financing elsewhere.
Supervision of a mortgage pipeline could include third-party experts who serve as the secondary marketing manager, particularly focused on the risk management aspect of the business. This can include regular analysis of the loan assets in the pipeline as well as hedge instruments to measure value changes.
Part of the task for such managers is to establish the real market value of the loans in the pipeline. This helps form a strategy for hedge transactions, which aim to protect the value of the assets in the pipeline by selling loans through forward sales. The manager assesses which loans represent the most exposure to interest rate changes, then choose loans that have a matching correlation to those market changes. By selling certain mortgages when interest rates increase, those transactions become more valuable and offset declines in value that may occur with the loans that are retained in the pipeline. This is comparable to balancing “short” and “long” positions on assets.