Posted
Happy Settlement Day!
Remember late in the day on Friday when everyone panicked
because they thought the floor had fallen out from under MBS prices? Well not to worry, that was just
the end of the May MBS trading month and the roll forward to new, freshly minted June MBS coupons.
The MBS coupons that determine your rate sheet pricing are
traded in the TBA MBS market...TBA = To be Announced. In the TBA market, at the time of a trade, buyers
and seller agree to only a few specific terms, like what coupon, the issuing agency
(Fannie or Freddie), and a buy/sell price....the actual pools of loans that will be
bought and sold are not disclosed at the time of this agreement. Instead, two
days before the pre-scheduled settlement date (determined by SIFMA), the MBS
seller "notifies" the MBS buyer of the specific pools that they will
deliver to satisfy the previously agreed upon trade. The MBS buyer then reviews the pool information
to ensure that the seller is delivering pools of loans that meet the agreed upon terms (which
were determined at the time of the trade). Then two days later, on settlement
date, funds are wired and the trade is complete (it goes deeper...this is the
outline of the trading process).
Why is there seemingly a price "Drop" when coupons roll forward to the next delivery month?
Leading up to notification day the TBA MBS market generally
goes quiet (part of the reason for the price drop) as most market participants have already identified a counterparty or perhaps they decided to roll forward to the
next months coupon ahead of settlement date.
The main reason behind the price "DROP" has to do
with the "time value of money". The longer you own the cash
flows...the more time the asset has to appreciate.
Plain and Simple: If you
own the May MBS coupon, then you are entitled to the coupon clips (income)...this income is generated from the underlying loan's principal and interest (passed through from borrower to MBS investor).
Well...if an MBS investor decided to wait until June to buy an MBS coupon...that investor is deciding to forego the cash flows they could
have been collecting from owning the May MBS coupon. So to compensate for the lost "time value of money" generated income...prices drop when delivery month rolls over!!!
What Determines "THE DROP"?
Whether or not it is worth owning the May coupon vs. the
June coupon is predicated off of several complicated factors...expected prepay speeds vs. actual prepay speeds, market supply/demand (need to
cover short/dont need to cover short position), and financing costs. If you are curious here is an
example of Dealer A and Trader B discussing the ROLL.
Why do we need the TBA MBS Market?
The TBA trading mechanism plays a very important role in the
generation of mortgage rates. The TBA market allows originators to make
"forward commitments" before the loans in their pipeline are actually
closed...just like loan officers lock in interest rates before the loan closes.
For both the mortgage bank and the loan officer, this function serves as a hedge.
It allows them to protect their pipelines from interest rate risk (rates
getting higher and their loans not being worth as much). If mortgage bankers were forced to lock in their rates after closing...they would add in a large "interest rate risk" premium to protect themselves from shifts in the yield curve.
Plain and Simple: Without the TBA market
mechanism...mortgage rates would be much higher!!!
Since 5pm "Going Out" Marks....
FN30________________________________
FN 4.0
-------->>>> +0-03 to 100-01 from 99-30
FN 4.5
-------->>>> +0-01 to
101-24 from 101-23
FN 5.0
-------->>>> +0-04 to
102-23 from 102-19
FN 5.5
-------->>>> +0-03 to 103-17
from 103-14
FN 6.0
-------->>>> +0-03 to 104-24
from 104-21
GN30________________________________
GN 4.0
-------->>>> +0-02 to 100-02
from 100-00
GN 4.5
-------->>>> -0-01 to 101-29 from
101-30
GN 5.0
-------->>>> +0-00 to
103-10 from 103-10
GN 5.5
-------->>>> +0-04 to 103-31 from 103-27
GN 6.0
-------->>>> +0-04 to 104-22
from 104-18
UST10YR: 3.1783%
2s/10s: 228.91
bps
DOW: -33 to 8385
The 10 yr TSY note is near its price highs of the session (yield lows) and the Dow is sluggishly testing and retesting its downside support. The MBS market continues to trade in light volume environment as most market participants are finishing up settlement and others are
looking for new direction from the yield curve (which is very
indecisive at the moment). Fixed income buyers are having difficulty balancing the willingness and timing of Fed buying with bond supply fundamentals. This leaves us in limbo until the Fed alters the market's sentiment/perception of Fed behavior to come....
Slow flows has created volatile price swings. Look how choppy its been today....
