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Fannie Mae securities catch a bid on the bond rally

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Fannie Mae and the to-be-announced market

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. In this chart, we see the Fannie Mae 3.5% coupon for the November delivery.

Fannie Mae TBA

TBA market ticks up as the bond market rallies

Fannie Mae MBS rallied slightly on a very strong bond market. The Fannie Mae 4% TBA started the week at 103 5/32 and picked up about 18 ticks to close at 103 23/32.

The main action driving TBAs seems to be from Washington, between the Fed purchases and the government’s policies to drive origination. For more on these drivers, read Loretta Mester weighs in on economic outlook and monetary policy.

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 

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Mortgage REITs and exchange-traded funds (or ETFs), such as Annaly Capital Management (NLY), American Capital Agency (AGNC), Capstead Mortgage (CMO), the iShares 20+ Year Treasury Bond ETF (TLT), and the VanEck Vectors ETF Trust (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 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, which hedge some 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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