For most FHLBank members, the delivery commitment (DC), or rate lock, is viewed as a loan-specific commitment opened for funding one particular loan. It doesn’t have to be. With the Mortgage Partnership Finance® (MPF®) Program’s Traditional products and mandatory delivery, the DC is actually not loan specific.
As a result, you will notice you are not required to provide any loan specific data. You are truly locking in a term (30-year fixed), amount, rate and timeframe for delivery. This can be beneficial in those instances where you need to substitute a loan (or loans) for one that has fallen out. Developing an understanding of how DCs work can help you use them in a manner that reduces pair-off fees.
When you choose to set up DCs on a loan-by-loan basis, you may be opening yourself up to more exposure than you realize. For example, if you have three loans that need DCs and you choose to use individual locks, it would look like this:
You now have three DCs opened at various dollar amounts and two interest rates. The MPF Program allows a 5% tolerance between the DC amount and the actual funded loan amount. As a result, the potential exposure subject to a pair-off fee is as follows.
Delivery Commitment #1
$150,000 – 5% = $142,500 (potential exposure)
Delivery Commitment #2
$200,000 – 5% = $190,000 (potential exposure)
Delivery Commitment #3
$95,000 – 5% = $90,250 (potential exposure)
In these scenarios, our best case is an exposure of $90,250, if the smallest loan falls out, while our total exposure is $422,750, if all three DCs fell through. You would be able to substitute new loans, but you are limited to very specific amounts to accommodate the new loans.
Let’s look at the same three loans placed under one DC.
The first thing you will notice is the DC’s interest rate does not match the interest rate for loan #3. That is acceptable, since we have a 0.25% tolerance on the rate giving us a spread from 3.75% up to 4.25% (where available) to go along with the dollar amount tolerance. Therefore, we can sell a 4.125% loan into a 4% DC. Let’s run through the same scenarios as above with just the one DC.
Delivery Commitment #1
$445,000 – 5% = $422,750* (potential exposure)
If Loan #1 Fell Out
With the loss of the $150,000 loan, our total loans funded reduces to $295,000, but our actual exposure (for pair-off fee purposes) is $127,750, not the $142,500 from our previous individual DC example. By combining all three loans into one DC, we reduce our risk by $14,750.
If Loan #2 Fell Out
With the loss of the $200,000 loan, our total loans funded reduces to $245,000, but our actual exposure is $177,750, not the $190,000 from the previous individual DC example. With the combined DC, we reduce our risk by $12,250.
If Loan #3 Fell Out
With the loss of the $95,000 loan, our total loans funded reduces to $350,000, but our actual exposure is $72,750, not the $90,250 from the previous individual DC example. Again, with the combined DC, we reduce our risk by $17,500.
In any of the three scenarios above, the actual remaining exposure to your institution, if a loan from the bulk DC falls out, is less than if that loan were to fall out of its own DC. That is due to maximizing the 5% tolerance across the board with the higher DC amount; thus, reducing the exposure if a pair-off fee is assessed.
With this process, you are not only reducing your actual exposure for pair-off purposes, you are also increasing the available loan amounts for substitution. With the bulk delivery commitment, we increase the tolerance spreads on both ends of the range allowing for more flexibility when attempting to substitute new loans into an existing commitment and avoid pair-off fees.
This process is not for every institution or every group of loans. Individual DCs make the most sense in some situations, especially when you don’t have the activity to justify bulk DCs. As these examples show, however, it doesn’t take much volume to make bulk DCs a more attractive option.
*Please note the potential exposure under this scenario is the same as the accumulated exposure of all three DCs listed above. We have not created more exposure with this process, but we have reduced the realistic exposure if a loan falls out.
“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago.