10.2.26 Industry Chatter; Eris Innovations’ Geoffrey Sharp on Options; Poor Payrolls Friday

Robbie ChrismanWelcome to the Chrisman Commentary, Daily Mortgage News Podcast. I'm your host, Robbie Chrisman. Topics on today's episode include some conference chatter, including UAD 3.6 updates. My rates trending water is better than rates going up. And my interview with Eris Futures, Jeffrey Sharp, on how futures contracts replicate the cash flows and functionality of over-the-counter interest rate swaps. Here, take a listen, do a little preview. Robbie ChrismanWhen we talk options or swaptions as it pertains to mortgage, what are those for the uninitiated? Jeffrey SharpYeah, yeah, yeah. So an option, loosely speaking, is the option to enter into a position as opposed to have an obligation in that position. So when you buy or sell a swap or buy or sell a TBA or buy or sell a treasury future, that is an obligation to meet the terms of the thing you've sold or bought. In the case of a treasury future, you're selling treasury futures forward. In the case of a TBA, you're obligated to deliver mortgages into the sale of the TBA. In the case of a swap, you're obligated to either receive fixed or pay fixed against a floating leg. So you're locked into what could loosely be called a linear payout profile. It's not exactly linear, but it's good as linear from a local standpoint. Linear meaning rates go up, you lose money on a long position, rates go down, you gain money on a long position because you know long is long interest rates. Options, on the other hand, give you the ability to only have one side of the exposure. So if you buy a call option on mortgage prices, i.e., when rates go down, mortgage prices go up. If you buy a call option on mortgages, then that option is going to go up in value when mortgage rates go down. But when mortgage rates go up, that option's not losing you any money more than the premium you pay for that option. So people talk about hockey stick profiles, and we all know what a hockey stick looks like. Compare that to a linear profile, which is just a straight line, and you overlay a hockey stick on top of that, and you can see that when you buy an option, you've got no downside beyond the cost of that option. Whereas when you buy the underlying, you have linear upside and downside when rates go up or down. Robbie ChrismanThanks to this week's podcast sponsor, Gateless. Intelligent automation that gives you the competitive edge. Gateless solutions reduce costs, deliver a superior borrower experience, and mitigate risk by automating tasks and decisions historically made by people. To learn more, visit Gateless.com. A clear conscience is usually the sign of a bad memory. How's your memory of rates and what you did when they moved higher? 30-year mortgage rates were about at this level, briefly, exactly three years ago. But before that, we weren't here since the late 1990s when they were at these levels for a long time. How many of your sales staff were in the business then? As the United States deficit continues to increase, five-year Treasury securities issued at 1% are paying off, and the U.S. government is now having to pay 5% on new five-year Treasury notes. At the Virginia Mortgage Bankers Association conference, hello from Charlottesville. Which wraps up today, the talk on the state and in the hallways revolved around this relatively high-rate environment, AI, credit changes, LOs being relevant, and how lenders should pay attention to demographics. Speaking of demographics, home prices in all 50 of the largest U.S. metros have grown faster than inflation since 2011, according to a new report from Clever Real Estate. Inflation rose 48% between January 2011 and January 2026, while home price growth over that span ranged from 65.5% in Baltimore to 343.9% in Miami. The gap runs even wider over the past four decades. The median U.S. home sold for $78,200 in 1984 and sells for $423,100 today. An increase of 441%. Inflation, on the other hand, rose just, and I put that in air quotes, 210%. If home prices had risen only as much as inflation, the median home would cost $242,000. A gap of $180,791. Wage growth is often measured against inflation. U.S. real median household income reached a record $87,460 in 2025, rising 2.6% from 2024. This surpassed both the pre-pandemic 2019 level and the previous post-pandemic high, signaling broad improvement in inflation-adjusted household earnings. Although it remained below the unusually elevated 2020 and 2021 levels when pandemic stimulus and tax credits boosted household resources. The gains, however, were unevenly distributed. While incomes at the 90th percentile rose for a third consecutive year, income at the 10th percentile was statistically unchanged from 2024. Over the longer term, the disparity is even clearer. Since 1967, income at the median and 10th percentile has increased roughly 56 percent, compared with 121% at the 90th percentile. Consequently, despite the historical median income level in 2025, the data highlights a persistent and widening distributional divide, with the income of households at the 90th percentile reaching roughly 13 times that of households at the 10th percentile versus 9.2 times in 1967. And I do want to talk about what's going on in Washington, D.C., since I was just there yesterday. Bill Pulte has his proponents and his detractors. And the question out there is is he good for housing? The Federal Housing Finance Agency on Wednesday evening announced cuts to the budget of the regulator's inspector general, a move criticized by many as an attempt by FHFA Director Poulte to shut down the watchdog. FHFA said in a press release that its Office of Inspector General was an extraordinary budgetary outlier among its peer OIGs, because its budget request was 16 percent of the agency's operating budget compared to an average of 2 percent. And FHFA cannot justify such a discrepancy to the American people. FHFA is moving Freddie and Fannie to dual merge credit checks. Some have commended him for this action, including CHLA to require conventional mortgages and mortgage-backed securities to have a Fannie Mae or Freddie Mac credit score to go along with a FICO Classic or VantageScore number. Remember, neither Freddie nor Fannie use a credit score to determine whether they will buy a loan. And it's worth asking if lenders pull both FICO and Van Inage Score, and both must be disclosed to the GSEs. Who's actually ready to operationalize that on the verification side? Other questions arise. What happens upstream at the credit report level when lenders start pulling dual scores of volume? The verification infrastructure has to be ready before the investor infrastructure can catch up. And that's a detail most coverage skips. Someone wrote to me and said if the purpose of introducing VantageScore 4.0 is to increase competition and lender choice, how are FHFA and the GSEs addressing the disparity between direct sellers and lenders dependent on correspondent aggregators? Rocket and UWM have direct execution available, while smaller lenders may originate a GSE eligible loan, but have no correspondent investor willing to purchase it. What's being done to ensure that the new scoring model is commercially accessible across all lender channels rather than primarily benefiting institutions with direct GSE delivery? And before we go here, I do want to touch on UAD 3.6, which uh made some news uh this week as there is a policy exception Fannie Mae and Freddie Mac announced, which gives sellers who need more time a path to keep delivering 2.6 reports through May 19, 2027. It looks like AMCs appreciate the GSEs giving the industry that flexibility. It's a sensible backstop, but the November 2nd mandate still stands and the execution has to be requested and comes with an implementation plan. It's probably prudent for lenders to use the extra runway to prepare well, not slow down. For lenders still getting comfortable with the new report, hybrid appraisals are a practical way to get real experience with 3.6 now, and they've delivered meaningful cost savings for lenders and borrowers alike. For lenders who want more support through the changeover. There's also appraisal and underwriting assurance that can take some of the review burden off their teams on both traditional and hybrid appraisals in either format. And finally, getting to rates here, have long-term yields finally reached a self-stabilizing level yet? U.S. Treasuries yesterday rebounded from a global sell-off as pressuring European markets fueled demand for haven assets, pulling ten-year yields down from a 24-year high, and the two-year treasury yield lower by 10 basis points to 4.79%. The rally looked more technical and position driven than fundamentally motivated. And certainly there was some seller fatigue after Wednesday's pressure, as well as some end-of-week positioning ahead of payroll. After strong labor data and a sharp rise in ISM prices paid initially pushed yields new highs, with the 10-year yield touching 5.34% and the 30-year reaching 5.69%. It's high since 2002. The move reversed as those levels failed to hold, and Minneapolis Fed President Kashkari offered notably neutral commentary on the path of Fed policy. Markets sharply reduced the implied probability of an October 25 basis point Fed hike, while Fed officials Jefferson and Williams emphasized that future policy decisions may require more time. Particularly after being caught leaning the wrong way earlier in the week. Payrolls now have the potential to determine whether this rally has legs or was simply a pre-data positioning adjustment. While the underlying tension between resilient growth and elevated inflation persists, investors don't seem to be worried about runaway inflation as much as the Fed's potential response to it, as well as uncertainty surrounding Chair Warsh's leadership. The Fed's recent hike may strengthen its credibility, but higher front-end rates cannot directly address a one-time energy-driven supply shock. Beyond the Fed's near-term path, the bigger question is how far higher long-end borrowing costs can extend before they weigh meaningfully on risk assets, as equities have so far remained resilient despite elevated rates, while oil above $90 and the ongoing Iran war add uncertainty, but have not yet produced a major rise in long-term inflation expectations. For today's interview, I wanted to welcome back to the show Eris Futures, Jeffrey Sharp, to talk about how futures contracts replicate the cash flows and functionality of over-the-counter interest rate swaps and how they're suitable for short-term trading or long-term hedging. He's managing director and head of product at Aeris, having joined the company in 2015. He has over two decades of global capital markets experience and is incredibly well-versed on fixed income capital market sales and swap futures. Let's hear from him. Robbie ChrismanLast time I had you on the show, we talked about hedging non-agency and the tools now available to make that more efficient. That's a small subset of the market. I'm going to kind of hand over hosting duties here for a second. What are we here to talk about today? Jeffrey SharpRobbie, first of all, nice to see you again. Speak to you again. We love the work you guys are doing. And you know, we get a shout-out every time our name gets a mention in either the commentary or the podcast. So thank you very much. Robbie ChrismanGood stuff. Jeffrey SharpLast time, you know, I sort of showcased the fact that we had introduced a very easily accessible interest rate swap contract that can be used to hedge interest rates. And one of the things we discussed initially was why SOFR and not treasuries. And I think we summarized that when you're underwriting loans, you're financing it on your balance sheet with SOFR. So the right thing to do is hedge it with SOFR, as opposed to any other instrument to remove the basis risk between your assets, which is what you're underwriting, and your liabilities, which is SOFR, the rates you're paying to finance those positions. So it's natural you would use SOFR. And we created this very liquid, very easily accessible SOFR interest rate swap product traded on the CME Group, the world's largest futures exchange. And I'm here today to introduce a new product that we have added to the suite of the Eris SOFR complex, and that is options on these products. These products will launch in June. I'm very excited about this. I used to be an option trader myself, swaption trader, and the biggest users of swaptions, funnily enough, were the big mortgage companies. They're either hedging or the hedging uh their portfolio. When it comes to pipeline, which is what we'll focus on most, um, it's around origination risk. And when they're hedging the portfolio, it's typically around the mortgage servicing rights. Um, maybe it's some collateral too, but mortgage companies don't hold on to their mortgages, they sell them, but they do hold on to their servicing. And servicing has a tremendous amount of negative convexity exposure embedded in it. And swaptions are a very big part of that portfolio valuation model, and therefore an important part of the hedge. So, this is a topic that's actually something that I'm pretty excited about. Robbie ChrismanWell, before we get into the meat of the conversation here, I want to congratulate you and Eris. Sounds like you had record volumes in September. Any color you can provide there? Jeffrey SharpYeah, it's been uh it's been a bit of a tear, actually. Since CME initiated margin netting of errors and swaps back in 2023, open interest has risen five fold, and we hit a record of 857,000 contracts, so that's 85 billion if notional a couple weeks ago. And with you know, September will be probably another record month of over five billion a day, probably over not probably already over a hundred billion in volume traded in Aeroswap futures for the month. Uh and this is a combination of a growth of the participant uh user base, uh, a massive expansion of the market maker list. A year ago, there were probably three or four what I call big bulge bracket market makers, then now ten with at least two or three more in the wings that should be onboarding over the next six months. So it's really becoming an integral part of the overall fixed income market. Robbie ChrismanGood to hear. So when we talk options as it pertains to Eris, what is the latest and greatest? Jeffrey SharpYes. Okay. So let's talk about that. First of all, we've talked about what an option is. Now let's translate that into what's happening in the origination pipeline. Last time I said we talked a little bit about a little corner of the market and non-agency space. But when you consider the whole mortgage market, there is a common exposure that underwriters take when they write agency loans, and that is this pull-through risk. And this pull-through risk is an option that the originator is selling to the home buyer, the mortgage borrower. You and I, mortgage borrowers, we go write a million dollars worth of mortgages, and we both believe that our pull-through rate is going to be about, let's say, 75%. So 750,000 of those loans are going to close in a static environment where rates are relatively stable. But if rates back up 25 basis points as they have recently, certainly they've backed up, you know, 100 basis points in the last six months. As rates move around, that 75% pull through may change. It may be 100% because rates back up by 25 basis points, and all those home buyers said, you know what? I'm taking those loans that Jeff and Robbie locked for me, and we get stuffed with a million dollars, and we only hedge 750,000 with TBH. So on $250,000 worth of mortgages that we locked at 25 basis points lower, we've got some loss associated with having to reset or fund the loan at 25 basis points higher than the rate that we underwrote. So that option that the home buy essentially, you know, the lock spot can be covered by buying options on soap. The behavior of an error's option is actually not that different to the behavior of the price of the mortgage as a result of this change in pull-through. So when it comes to using swaptions, and in this case, eris options, options on soaper rates, it's actually a very easy exercise. The odd is deciding how much of your portfolios you're gonna hedge. So you could say, you know what? I'm gonna hedge all of it. I've underwritten a million dollars worth of loans. I'm gonna buy a million dollars worth of options. They trade in 100,000 notional unit lots, and the extra money options on the five-year tail might be only $500. So this protection is not expensive. $500 on you know, $100,000 worth of loans. So you know the average loan is probably going to say $400,000. You're talking about $2,000 custom protection. Now, on a single loan of $400,000, that's a lot of money. But now you consider well, I'm only really hedging that element of my pull-through risk. I know that at a worst case, I'm gonna see 50% pull-through. I think I'm gonna get 75%. But if rates move around, I could see that pull-through drop to 50, I could see it drop uh rise to 100. So really I'm only hedging a small portion of that. So now you've got an instrument that you can easily access in the market by just trading this listed option. And then lots of different strikes. You don't have to hedge the money. You can say, well, if I want to hedge if rates back up 25 basis points, I want protection over the 25 basis point rates. Or you might want to go the other way and say, I want to carry no hedges, and then I'm just gonna do 100% protection by buying 100% of, you know, if pull through rises to 100% in a 25 basis point backup, I'm gonna buy 100% notional of my options, 25 basis points out of the money. What that means now is if rates fall, I get all the gain on the mortgages I've underwritten. And if rates fall, I'm able to deliver those mortgages into a higher TBA price in a month's time. The key here is access, simplicity and access. This may all sound a little bit complicated, but once you start looking at numbers on paper, it actually the easiest way to think about this, in all honesty, is think of the option that you're selling to the home buyer. That option is replaced by buying this option in the futures market. Robbie ChrismanCan you speak to the importance of these options and people working with Eris, especially in this current market environment that we're in? Jeffrey SharpYeah. Well, we'll start with that and we'll go back to the first question. We have over the last three years created a lot of more current coupon mortgage. I mean, the lion's share of outstanding coupons is still low coupon mortgages, and there's not a lot of negative convexity in those mortgages. Negative convexity means that there's an asymmetric payoff when rates go up versus down in these instruments. If there was a symmetric payoff, it'd be very easy. We could just put on a swap hedge or a rate hedge, and rate hedges are linear and mortgages are nonlinear. If mortgages were linear, you could lock it up, collect your interest margin or your edge, and we could go back to making a new mortgage. But because mortgages are nonlinear, a lot more negative convexity is being introduced into the current rate environment. So over the course of the last three years, there's a lot of mortgages that have been created between, you know, call it six to six and a half percent coupon. We're up at six and three quarters. We're gonna produce a bunch of mortgages up here at six and three quarters. And the more current coupon mortgages we produce, the more negative convexity we introduce into the bond market, the mortgage bond market, and the more asymmetry that needs to be hedged. And that is something that's been a sort of a rising concern over the course of the last three years. The uncertainty that we sit with right now, I mean, you know, we had a Fed hike, the market is discounting another Fed hike before the end of the year. Probably even at the next meeting. I think it's 50% discounted at the next meeting, right? There's a lot of uncertainty. And that uncertainty is optionality. And it makes it very difficult for originators, it makes it very difficult for portfolio retention, both on the mortgage bond side and on the mortgage servicing side. And easy access to an option is actually sort of a critical innovation. To go back to your first question, why didn't this exist before? I think this is the market evolution associated with what's happened over the last 15 years. You go back 10, 15 years, the non-bank mortgage space was only 15% of the participants in the market space. And the professional banks were the lion's share of that market. Today, the non-bank financial, non-bank independent mortgage banks are 85% of the market. They're very good at making the mortgages and servicing customers, but they don't necessarily have a risk management portfolio trading background. And that evolution is developing. And the big mortgage companies now have built very robust risk management teams, portfolio management teams, and they know how to use these tools and are scrambling and calling for where's the efficient access to those options and swaps that I used to use when I was at Bank of America, corporate treasury, or JP Morgan Corporate Treasury. So I think it's an evolution element that's going on here. And then the global financial crisis forced a lot of people into, well, forced the whole market into central clearing, more skin in the game, and that forced what were efficient bilateral derivatives into central clearing and margining. And listed products are just that much more efficient than bilateral and OTC products, significantly more capital efficient than OTC and bilateral products. So it's a transition. Robbie ChrismanI don't want to overstate the point here too much, but how has acceptance or use been? How do you hope it goes? Who are you targeting here today? Jeffrey SharpYeah, so independent mortgage banks, mortgage companies with servicing exposure, I think are the early adopters of this product because their alternative is OTC swaps and TBA options. And those are relatively expensive and inaccessible to the smaller players. You need ISDA agreements or master agreements that are very cumbersome. And in the bilateral space, the capital cost for the dealer means that trading small size is really inefficient. So having an accessible 100,000 notional lot instrument where you can look on the screen and see a price and trade it very, very quickly, and then trade out of it very, very quickly if you want to is a huge value proposition. Of course, there's an ecosystem that we have to develop. So we've been working with the big vendors, obviously Optimal Blue, the QRMs, the PolyPaths of the world, you know, the vendors that provide risk management services to the independent mortgage banks. So that process is taking its time, but the appetite is there. And then as it grows, it expands into more institutional use. Very similar to what happened with the Aeroswap futures contract itself. So it's early days, but there's value here. Robbie ChrismanFor more information, best next steps. Jeffrey SharpSo the best next steps are, you know, if you don't have a futures broker, reach out to us. We can certainly introduce you to a couple. I would encourage you to talk to your vendors. You know, your vendors could be MCT, your vendor could be Optimal Blue. If you're on the service consisting servicing side, it could be a MIAC or QRM. But reach out to your vendor. If you don't have a futures broker, reach out to us. We can introduce you to a few. Obviously, your Wall Street banks are uh another port of call. They are increasingly starting to trade the Eris Swap futures contracts. And then, you know, we're certainly happy to provide education and introduction. A good starting point would be our website, ErisFutures.com. We're open. Our job is to educate. We're not a vendor, we're not participants in the trade, so we don't really know who's trading our product. We're here to educate and introduce, and we work obviously extensively with CME. Robbie ChrismanWell, I appreciate you coming on today to educate and introduce. And uh it's always a pleasure speaking to you. So hopefully we'll have you back on soon, Jeffrey. Jeffrey SharpGreat, Robbie. Nice talking to you again. Robbie ChrismanToday's economic calendar is already underway with the aforementioned September job information. September nonfarm payrolls were only up $29,000, about 60,000 lower than expected with a serious back month revision lower. The unemployment rate was 4.2% versus 4.1% previously. And average hourly earnings were only up 0.1%. After the week employment data, agency MBS prices are better than Tuesday’s close by a quarter to three eighths. And the 2-year yielding 4.69%. The 10 years yielding 5.15 after closing yesterday at 5.24%. Let's wrap up for the joke and the easiest way to find something lost from the house is to buy replacement. Gateless is intelligent automation that can give you the competitive edge. And decisions historically made by people.