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Introduction to MBSD

5.00 ( 2 votes )

A mortgage-backed security represents an ownership interest in mortgage loans made by financial institutions to finance a borrower’s purchase of a home or other real estate. Mortgage-backed securities are created when mortgage loans are packaged, or “pooled,” by issuers or servicers, and securities are issued for sale to investors. As the underlying mortgage loans are paid off by the borrowers, the investors in the securities receive payments of interest and principal.

Mortgage-backed securities play a crucial role in the availability and cost of housing in the United States. The ability to securitize mortgage loans enables mortgage lenders and mortgage bankers to access a larger reservoir of capital, which makes financing available to home buyers at lower costs and spreads the flow of funds to areas of the country where capital may be scarce.

Asset securitization began when the first mortgage pass-through security was issued in 1970, with a guarantee by the Government National Mortgage Association (“GNMA” or “Ginnie Mae”). The most basic mortgage-backed securities, known as pass-throughs or participation certificates (“PCs”), represent a direct ownership interest in a pool of mortgage loans. Shortly after this issuance, both the Federal Home Loan Mortgage Corporation (“FHMLC” or “Freddie Mac”) and Federal National Mortgage Association (“FNMA” or “Fannie Mae”) began issuing mortgage-backed securities.

Although mortgage-backed securities are fixed-income securities that entitle investors to payments of principal and interest, they differ from corporate and Treasury securities in significant ways. With a mortgage-backed security, the ultimate borrower is the homeowner who takes on a mortgage loan. Because the homeowner’s monthly payments include both interest and principal, the mortgage-backed security investor’s principal is returned over the life of the security, or amortized, rather than repaid in a single lump sum at maturity.

Mortgage-backed securities provide payments to investors that include varying amounts of both principal and interest, due to the flexibility that the homeowner has in being able to pay more than the minimum payment required by the loan agreement. As the principal is repaid, or prepaid, interest payments become smaller because the payments are based on a lower amount of outstanding principal. In addition, while most bonds pay interest semiannually, mortgage-backed securities may pay interest and principal monthly, quarterly or semiannually, depending on the structure and terms of the issue. Most mortgage pass-through securities are based on fixed-rate mortgage loans with an original maturity of 30 years, but typically most of these loans will be paid off much earlier.

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Mortgage-backed securities are traded in the over-the-counter (“OTC”) market, and much of the volume in the agency mortgage-backed securities market today is in the form of To-Be-Announced (“TBA”) trading. A TBA is a contract for the purchase or sale of mortgage-backed securities to be delivered at a future agreed-upon date; however, the actual pool identities or the number of pools* that will be delivered to fulfill the trade obligation or terms of the contract are unknown at the time of the trade. The TBA market is based on one fundamental assumption – homogeneity. TBA trading is based on the assumption that the specific mortgage pools which will be delivered are fungible, and thus do not need to be explicitly known at the time a trade is initiated**. At a high level, one pool is considered to be interchangeable with another pool.

Actual mortgage pools guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac are subsequently assigned or “allocated” to the TBA transactions to be delivered upon settlement. Settlement dates are standardized by product type (e.g. 30-year Fannie Mae/Freddie Mac pools, 30-year Ginnie Mae pools). Monthly settlement date calendars for the TBA market are published up to one year in advance by a Securities Industry and Financial Markets Association (“SIFMA”)*** committee on a rolling 12-month basis. This is done to increase the efficiency of the settlement infrastructure. Pools may, however, be settled on days other than the established settlement date if the parties to the trade so desire.

For example, in a typical trade, a buyer may ask to purchase $100 million of 30 year Fannie Mae Mortgage-Backed Securities with a 6% coupon for delivery next month. The buyer does not know the exact pools that will be delivered. According to industry practice, two days before the contractual settlement date of the trade (known as 48-hour day), the seller will communicate to the buyer the exact details of the mortgage-backed securities pools that will be delivered.

The TBA market is the most liquid, and consequently the most important secondary market for mortgage loans in the world. Market participants that benefit from TBA trading include mortgage bankers, commercial banks, and thrifts that originate residential mortgages and sell them into the secondary mortgage market in securitized form.

During most mortgage application processes, a borrower may lock in a mortgage rate at some point prior to the closing of the loan. After this rate lock, the mortgage originator is exposed to interest rate risk: the risk that the value of the mortgage may change as market rates change before the mortgage is sold. Actual mortgage-backed securities pools can only be formed after the mortgages close; while the mortgages are awaiting closing, pool characteristics may shift if applicants withdraw their applications, postpone closing, fail to meet underwriting standards, or change loan amounts.

Originators frequently hedge their inventories (referred to as pipelines) of rate-locked mortgages by selling them into the TBA market as mortgage-backed securities for TBA delivery months in the future. TBA trading allows mortgage originators to sell prospective mortgage-backed securities before they know the specific collateral characteristics of the pools. Without the TBA mechanism, mortgage pools could not be sold until such pools had been formed, and originators would have to hedge their pipelines using Treasury future or Treasury or mortgage-backed securities options****.

TBA trading enables mortgage lenders to sell products forward through primary originations by securitizing the mortgages for purchase in the secondary market. To allow mortgage lenders to hedge or fund their origination pipelines, TBA settlements are often scheduled significantly ahead of the date on which the transaction is negotiated. This permits the lenders to lock in a price for the mortgages they are in the process of originating.

Take a look at the MBS Securitization Process Flow Chart below. Click the image to enlarge.

MBS Securitization Process Cropped

*Issuers create mortgage pools by combining mortgage loans with similar characteristics to use as collateral for mortgage-backed securities.
**Generic criteria (e.g. maturity, coupon, agency, settlement month and par) are determined at the time of the trade.
***SIFMA was formed in 2006 from the merger of the Bond Market Association and the Securities Industry Association.
****See The Handbook of Mortgage Backed Securities by Frank Fabozzi

5.00 ( 1 votes )

The allocation process revolves around the Good-Delivery Guidelines, which SIFMA establishes and publishes. For example, pool deliveries for trades of $1 million must consist of a maximum of three or five pools1 with the same coupon, and the variance permitted is plus or minus 0.01% of the agreed to dollar amount of the trade.2 Understanding SIFMA Uniform Practices is critical to understanding the allocation process, as well as the principles that guide the clearance and settlement process.

SIFMA sets the settlement dates for the TBA market.  The pool allocation process is very time sensitive.  At least 48 hours prior to the settlement date (known as 48-hour Day), the seller must notify FICC by 3:00 p.m.3 (ET) of the mortgage pools it plans to deliver on settlement date.  For example, the July 2016 settlement date for Class A TBAs was July 14th, so pool allocations were due by 3:00 p.m. (ET) on July 12th.  Although the contractual settlement date (“CSD”) never changes, the delivery date for pools allocated after 3:00 p.m. (ET) is pushed back one business day, and for each subsequent business day the pool allocation is delayed, the delivery date of that pool is delayed.  For example, if a July 2016 Class A TBA was not allocated until after 3:00 p.m. (ET) on July 12th, the CSD would remain as July 14th but the delivery date for those allocated pools would be pushed back from July 14th to July 15th.  For each subsequent missed cutoff, the delivery date is pushed back another business day.  This delay means the seller now has to finance the pools and will incur financing charges.  As a result, delays in allocations can be expensive.

1The maximum number of pools to satisfy delivery is based on the coupon rate defined by SIFMA guidelines.

2For the complete list of good-delivery guidelines, see SIFMA’s Uniform Practices (

3EPN allocations with timestamp of 3:00:01 are considered to be late.

0.00 ( 0 votes )

While TBA trades are traded in the forward market, they are typically settled on the settlement dates established by SIFMA for the associated product Class (known as Classes A, B, C and D). The SIFMA classes and settlement dates are industry-recognized and provide the foundation of the FICC/MBSD TBA netting process. 


GPMs/Mobile Homes

5.00 ( 1 votes )

Pools delivered to settle a TBA obligation may be either newly issued or “seasoned.”  Because mortgage-backed securities are ultimately backed by mortgage loans, as homeowners make monthly payments the mortgage pools are amortized.  This means that the par value of mortgage-backed securities pools decreases on a monthly basis.  Each month Ginnie Mae, Fannie Mae and Freddie Mac issue the current pool factors.  Factors can be anywhere from one to zero.  A factor of one means the pool is newly issued and has not paid down at all, and a factor of zero means the pool is completely paid down.  The “original face” is the par value of a pool at the time of issuance.  The “current face” is the current value of the pool and is determined by multiplying the original face of the pool by the current factor.  The difference between the current face of a pool from one month to the next is the amount of principal that the investor (i.e. owner of the pools) has received.