So far, so good in the transition to UMBS
admin | May 31, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
One of the biggest changes in the history agency MBS, the blending of separate Fannie Mae and Freddie Mac TBA markets to a single one for uniform MBS or UMBS, has run with only a few minor hitches so far. TBA trading in UMBS started on March 12 for settlement starting June 3, exchange of Freddie Mac PCs for UMBS began May 7, and compensation for the exchange has run smoothly. Despite a few software bugs, a wrinkle in exchanging May’s pools and a slight premium for Fannie Mae TBA pools, the market seems ready for the transition to UMBS to go fully live on June 3.
Fannie TBA trading volume carries on in UMBS, while Gold TBA virtually stops
Conventional TBA trading hasn’t slowed with the advent of UMBS (Exhibit 1). Gold TBA trading typically was 10% of total conventional volume in 2019 but has fallen to virtually nothing in the months with UMBS TBA trading, since those pools can be exchanged and delivered into the UMBS contract.
Exhibit 1: TBA 30-year trading volumes (net of dollar rolls) by settlement month
UMBS does not appear to have hurt conventional TBA trading. UMBS TBA trading for June settle has already reached levels comparable with combined Fannie and Gold TBA trading from January through March.
Another way to show that UMBS hasn’t hurt conventional TBA trading is to compare conventional to Ginnie Mae volumes. For example, Ginnie Mae TBA trading averaged 18.7% of total TBA trading in 2019, and is 18.7% of TBA volume in June.
Exchange volume has been strong
On June 3 Freddie Mac will no longer issue new 45-day delay Gold pools—with the exception of Giants— taking the final step towards creating a security that is fungible with those issued by Fannie Mae. All new Freddie Mac fixed rate pools will carry a 55-day delay, while ARM pools will continue to use a 75-day delay.
However a major step was already taken on May 7, when the process to exchange legacy Gold pools for 55-day delay pools went live. Since pool exchanges could settle in May market participants had to be ready operationally, and 55-day delay pools are already circulating in the market. The pool an investor receives is known as a “mirror security” and is backed by the exact same loans as the original 45-day delay pool.
Roughly $71 billion of pools have been exchanged so far, which is roughly 5% of the outstanding balance of Gold pools. A portion of those pools are locked up in CMOs and cannot be exchanged, which means that roughly 6% of the available float has already been exchanged. The first exchanges settled on May 17 and there have been seven settlement days in all, so on average nearly 1% of the float has been exchanged each day. The next available settlement date is currently June 10—there is a blackout period from June 3 to June 7, when factors are released.
Importantly, there were no surprises regarding float compensation
A major concern of investors was that the compensation received for lost float when exchanging pools would be correct, and by all accounts it has been. Freddie Mac was very careful to create a transparent process for valuing the lost float and communicating the amount to the market directly and through Bloomberg. Yet until the exchange process was available there was the risk that an operational problem could affect the payment—the amount received timing, and so on.. So far those fears have proven unfounded.
Bloomberg’s trading system cannot yet process exchanged pools
On May 3 Bloomberg changed its ticker syntax for Freddie Mac 55-day delay pools and created a problem with Bloomberg’s trading system. The company had planned to use an “FN” prefix for any TBA-deliverable (UMBS) pool, and the “FR” prefix for all other 55-day delay Freddie Mac MBS. Now Bloomberg intends to use “FR” for all Freddie Mac 55-day pools regardless of TBA eligibility.
However, the change caused an issue with Bloomberg’s TOMS trading system, which became unable to process mirror pools. Trades of these pools must be manually booked and manually reported to TRACE. Bloomberg intends to release a fix on June 6. So while this is an operational burden it did not threaten to delay the single security go-live date.
One software platform did not immediately support exchanged pools
Another issue came up while testing the back office platform IMPACT, preventing it from processing changes for the first 7 days. The problem was resolved in a fix on May 14. This platform is very widely used and many customers chose to wait for the fix before exchanging pools. This contributed to very low volumes during the first week the exchange was open.
Some May Gold pools couldn’t be exchanged immediately
May is the only month during which Freddie Mac issued new Gold PCs while investors had access to the exchange process. This created some operational issues with exchanging May issue pools. The largest effect was on the multi-lender pools, which don’t settle until close to the end of the month, and therefore couldn’t be exchanged before May 30. Single-issuer pools settling from May 13 through May 28 were eligible for exchange four days after settlement, pools settling on May 29 and 30 were exchange eligible one day after settlement, and pools settling on May 31 are not eligible for exchange until the 5th business day (June 7).
A similar issue arose when creating supers, which were not permitted to settle until the fifth business day of June.
The Gold/Fannie swap no longer trades
Since the exchange process allows any TBA-eligible Gold pool to be exchange for its equivalent UMBS pool there is no longer any point in trading the Gold/Fannie swap. Investors can exchange the pool as needed or when they feel the float compensation is rich. Therefore the swap is no longer trading.
Some Fannie UMBS is trading at a payup
Some investors remain concerned that Freddie UMBS will prepay worse than Fannie UMBS. For example, the servicer mix in Freddie multi-lender pools is perceived as being worse than in Fannie pools, so the latter pools are currently trading at a slight payup.