TBA dollar rolls rise in 2019

admin | July 12, 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.

The Fed’s continuing exit from the MBS market has coincided with a significant rise in average daily TBA dollar roll trading, with flows from mid-2018 to mid-2019 nearly doubling. Fed MBS balances have dropped by $189 billion over that period and outstanding MBS have increased by $149 billion. Higher balances in private hands, the ongoing transition to uniform MBS, special financing in a number of dollar rolls this year and a rise in MBS refinancing all may be contributing to the rising tide of activity.

Dollar roll trading has surged over the last year

Dollar roll trading has increased sharply since the middle of 2018. Average daily dollar roll volumes reported by the New York Fed have almost doubled from roughly $77 billion in July 2018 to almost $140 billion in March 2019 (Exhibit 1). Dollar roll volumes have tapered off over the last couple of months but still remain very high.

Exhibit 1: Agency MBS dollar roll volume has jumped higher in 2019

Note: The dark blue line is weekly trading volume, the light blue line is a running average fit using LOESS. The data do not include cash transactions. Source: Federal Reserve Bank of New York, Amherst Pierpont Securities

The increased dollar roll trading may be related to the reduction of Fed MBS purchases throughout 2018. The Fed started reducing MBS balance in October 2017. Prior to that date, the Fed reinvested 100% of MBS paydowns into new MBS. Beginning in October the Fed permitted up to $4 billion of paydowns per month to run off their portfolio. This implies that the pools the Fed would have bought without QE were instead purchased by private investors.

Every quarter in 2018 the Fed increased the amount of MBS that they would permit to run off by an additional $4 billion per month, until reaching a maximum of $20 billion per month runoff in October 2018. Increases in the runoff cap decrease the Fed’s MBS purchases. In mid-2018 the Fed was purchasing less than $10 billion of MBS per month, and the amount fell below $1.0 billion per month starting in October 2018.

The Fed does not appear to have conducted any dollar roll transactions over the past few years. The Fed reports sale transactions, and all of the few sales reported were specified pool sales. It is likely that the private investors that replaced the Fed’s MBS purchases would dollar roll, and this accounts for some of the increase in activity.

TBA trading remains strong after UMBS

The clear rise in dollar roll volume as also come as the MBS market transitions to a single agency TBA security or Uniform Mortgage Backed Security. The anticipated and actual pooling of Fannie Mae and Freddie Mac securities into a single TBA market may also be contributing to better volume. TBA UMBS contracts started trading in March, and exchange of Freddie Mac Gold PC MBS for UMBS started in May. So far, investors have exchanged $144 billion of PCs for UMBS. This is a good first sign that UMBS has not hurt, and possibly improved, TBA liquidity.

Special financing and mortgage refinancing

Over the last few months most conventional 30-year rolls have generally offered financing very close to 1-month LIBOR.  However the 3.0% roll has at times offered better financing rates and is running special today.  This roll currently offers financing at 2.03%, which is about 30 basis points lower than 1-month LIBOR (2.33%).

Ginnie Mae II rolls have gone special more often than conventional rolls over the last few months, and in coupons ranging from 3.0% to 5.0%. And all of these rolls are currently offering special financing, well below 1-month LIBOR–the Ginnie II 3.0% roll is financing at 1.30%, the 3.5% roll at 0.73%, the 4.0% roll at 0.93%, the 4.5% roll at 1.35%, and the 5.0% roll at 1.93%.

The drop in interest rates this year and the rise in mortgage refinancing may also be adding to the rising dollar roll volume. Mortgage originators routinely hedge originations with TBA contracts and roll those contracts to manage pipeline interest rate risk. The MBA Refinancing Index has jumped from 1,335.6 on 5/31/2019 to 1,799.7 most recently, and the rising refi activity also may be driving the flow of dollar rolls.

While overall MBS trading volume has not surged as much as dollar rolls this year, it remains robust. But the relative rise in dollar rolling points to a larger share of MBS exposure coming through TBA forward contracts and dollar rolls than through cash positions.