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Don't be fooled—this short week means lots of important releases

Part 5
Don't be fooled—this short week means lots of important releases (Part 5 of 6)

Why Fannie Mae securities caught a bid as bonds rallied strongly

Fannie Mae TBAs

When the Federal Reserve talks about buying mortgage-backed securities (or MBS), it’s referring to the to-be-announced (or TBA) market. The TBA market allows loan originators to take individual loans and turn them into a homogeneous product that you can trade. TBAs settle once a month. Fannie Mae loans go into Fannie Mae securities. TBAs are broken out by coupon rate and settlement date.

Fannie Mae TBAEnlarge Graph

In the chart above, we’re looking at the Fannie Mae 4% coupon for the September delivery.

TBAs catch a bid as the bond market rallies

Fannie Mae MBS rallied a bit on a strong bond market. The Fannie Mae 4% TBA started the week at 105 26/32 and picked up about an eighth to close at 105 30/32.

The main action driving TBAs seems to be out of Washington, between the Fed purchases and the government’s policies to drive origination. Market participants may also be forecasting less volatility in interest rates. This benefits mortgage-backed securities. Also, the Financial Industry Regulatory Authority (or FINRA) is announcing new margin requirements for TBA securities. This will deeply affect smaller mortgage lenders.

Implications for mortgage REITs 

Mortgage REITs and exchange-traded funds (or ETFs)—like Annaly (NLY), American Capital Agency (AGNC), Capstead (CMO), the iShares 20+ Year Treasury Bond ETF (TLT), and the Market Vectors Mortgage REIT Income ETF (MORT)—are the biggest beneficiaries of quantitative easing. Quantitative easing helps keep REITs’ cost of funds low. REITs benefit from mark-to-market gains. This means their existing holdings of mortgage-backed securities are worth more as the TBA market rises.

The downside is that interest margins compress going forward because yield moves inversely with price. Also, as MBS rally, prepayments are likely to increase. This negatively affects mortgage REITs.

As a general rule, a lack of volatility is good for mortgage REITs because they hedge some of their interest rate risk. Increasing volatility in interest rates increases the cost of hedging. This is because as interest rates increase, the expected maturity of the bond increases because there will be fewer prepayments. On the other hand, if interest rates decrease, the maturity shortens due to higher prepayment risks.

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