But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.
Mortgage-backed securities are the starting point for all mortgage market pricing, and are the investment of choice for mortgage REITs
When the Federal Reserve talks about buying mortgage backed securities, it is referring to the To-Be-Announced (TBA) market. The TBA market allows loan originators to take individual loans and turn them into a homogeneous product that can be traded. TBAs settle once a month, and government mortgages (primarily FHA/VA loans) are put into a Ginnie Mae securities. TBAs are broken out by coupon rate and settlement date. In the chart above, we are looking at the Ginnie Mae 3% coupon for April delivery.
The TBA market is the basis for which your loan originator prices a loan. When they make a loan to you (as a borrower) your rate is par, give or take any points you are paying. Your originator will then sell it into a TBA. If you are quoted a 3.5% mortgage rate with no points, the lender will fund your loan and then sell it for whatever the current TBA price is. In this case, the TBA closed at 105 28/32, which means your lender will make just under 6 percent before taking into account their costs of making the loan.
The Fed is the biggest buyer of TBA paper. Other buyers are sovereign wealth funds, countries who have trade surpluses with us, and pension funds. TBAs are a completely “upstairs” market in that they don’t trade on an exchange and most trading is done “on the wire” or over the phone.
TBAs rallied last week on the prospect of further quantitative easing
Mortgage backed securities had the biggest gain since June of 2012 last week based on a confluence of events. First, the situation in Cyprus has created a flight to safety trade, where assets crowd into safe assets like Treasuries. Mortgage backed securities correlate well with Treasuries, so they rose in sympathy. Second, the Bank of Japan announced its own quantitative easing program. The Japanese Yen fell in reaction, and Japanese money began to pour into US assets, particularly longer-dated Treasuries and mortgage backed securities. Finally, the disappointing jobs report on Friday led the market to speculate that the Fed will maintain quantitative easing for the rest of the year. All 3 events pushed mortgage backed securities higher.
Implications for mortgage REITs
Mortgage REITs such as AGNC, NLY, and HTS are the biggest beneficiaries of quantitative easing, as it helps keep their cost of funds low and they benefit from mark-to-market gains. This means that their existing holdings of mortgage backed securities are worth more as the TBA market rises. The downside is that interest margins compress going forward as yield moves inversely with price. Also as mortgage backed securities rally, prepayments are likely to increase which negatively affects mortgage REITs.
Finally, REITs that are in the origination business will benefit from this move as it will encourage refinancing and make homes more affordable, at least at the margin.
© 2013 Market Realist, Inc.