Loan Fallout and Pair-Off Arrangements
In mortgage banking, particularly within secondary marketing activities, "fallout" and "pair-off arrangements" are concepts related to managing price risk associated with loan pipelines.
Loan Fallout
Fallout occurs when borrowers withdraw or do not close on their loan applications after committing to a loan. This often happens due to changes in market conditions, such as falling interest rates that allow them to seek more favorable terms elsewhere.
- Impact: If a bank has mandatory forward sales commitments to deliver a certain volume of mortgages to investors, significant fallout can leave the bank unable to meet these commitments with its own originated loans. This may force the bank to purchase additional loans in the secondary market at potentially higher prices, leading to losses.
Pair-Off Arrangements
A pair-off arrangement is a mechanism used by banks to manage the risk of fallout. If a bank anticipates or experiences significant fallout and cannot meet its sales commitments, it may choose to terminate its obligation to deliver mortgages by paying a fee to the counterparty (the investor). This fee is known as a pair-off fee.
- Purpose: Pair-off arrangements allow banks to mitigate potential losses from having to buy loans at unfavorable market prices to fulfill commitments, by instead paying a predetermined fee to cancel the commitment. This is a form of risk management for pipeline exposure.
Source material
- pub ch mortgage banking
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