If profit is the focus of business owners, shareholders, corporate executives, and regulators, then why are so few
risk managers focused on profit when we hedge? Managing value or profit is a mindset change for many. Often
risk policies and risk managers speak of being flat or fully covered. But sadly, the context in which the statement
is made is without reference to profitability (value). Instead hedgers and policies are focusing upon (or believe
they are focusing upon) loan volumes.

Shouldn’t we manage for the goal and not just the limits? Performance hedging differs from many other
approaches to hedging in the context in which it measures success and failure. Hedges are weighed in terms of
their net contribution toward achieving a profit / value goal and preserving a profit / value floor.

This approach allows the exposure question to have the appropriate context and be correctly normalized. A goal
phrased in terms of basis points of profit per each dollar of loans delivered is both more empowering and less
ambiguous than an alternative risk policy directive of covering a minimum of 90% of the loan volume.

Exposure in the performance hedging context is now seen over a landscape and not a single point in space and
time. The relative likelihood of the risk is stratified in such a way as to make efficient use of hedge devices and
avoid unwarranted transactions.

• Performance Hedging provides for a means to manage the moving parts / risks that can decrement value:
  Fallout / Pair-off Risk
• Systemic Risk (Price Sensitivity)
• Basis Risk (Rate Sensitivity)
• Non-systemic Risk (Investor viability / stability, pricing idiosyncrasies)
• Execution Risk (hedge liquidity, cost to execute a transaction)
• Marketing Risk (volume size, volume consistency and volume quality...delivery selection and delivery issues – realm of best execution, work flow management, and loan/data quality management)

A Solution for the Information Age

We believe that many risk managers have been diverted from this path due to growing up with the legacy of older
technologies that required simple techniques and / or drew upon financial engineering tools designed for other
business models. These once state of the art approaches patched solutions, meant for other industries, over to
mortgage banking and were presented as the panacea to cure all ills. We’ve all heard knowledge is power and
we are living in the information age. It follows that the unquestioned utilization of the black box solution or
following an approach solely because others do it does not necessarily lead to remarkable performance.

Greg Crosby manages the secondary marketing software and services product line having joined ASC in June 1997. Greg has been involved in the mortgage industry since 1981. His fields of experience include secondary marketing, financial and performance auditing, construction and design of financial conduits, software development, commodity and securities portfolio management, and design of risk assessment systems. He developed the Risk Manager and Servicing Shepherd™ software products. Greg has served as a chief financial officer, with both commercial banks and investment securities brokerage firms, and has served as an advisor and board member to companies ranging from service providers to financial conduits. Greg is considered an industry expert in the fields of secondary marketing and risk management has authored numerous articles, papers and a book titled The Theory and Practical Application of Improving Secondary Marketing Performance with Software Tools.