What Are Mortgage Allocations?

Mortgage allocations are a step in the settlement of to-be-announced (TBA) mortgage-backed securities (MBSs) that are traded in the secondary market. At assignment, the seller provides the buyer with the precise details of the loans that make up the underlying pool of the MBS.

Understanding Mortgage Allocations

Mortgage-backed securities (MBSs) are financial securities created by pooling multiple 澳洲幸运5官方开奖结果体彩网:mortgages into a repackaged security and selling them to an investor. After a mortgage lender provides a loan to a borrower, the loan can be sold🍸 and packaged with other home loans into a security investment (i.e., an MBS). The buyer of an MBS receives a stream of income from the interest payments made by homeowners on those mortgages.

When traded in the secondary market, the underlying mortgages that make up a specific MBS are unknown. Mortgage allocation is the process by which a seller of an MBS details the mortgages that make up the 澳洲幸运5官方开奖结果体彩网:to-be-announced (TBA) MBS by a certain date and time.

Mortgage Allocation Process

When a buyer and a seller agree on a TBA trade, they fundamentally agree to the terms of a contract. The parties agree on the issuer, maturity, coupon, price, and par amounts oꦏf the traded securities. Beyond these criteria, the underlying loans are considered interchangeable. That also means that the buyer and seller are unaware of the qualit🐲y of the underlying mortgages in the MBS.

This interchangeability facilitates trading and liquidity in the 澳洲幸运5官方开奖结果体彩网:secondary market. The buyer and seller also agree on the date of 澳洲幸运5官方开奖结果体彩网:settlement for the trade. Two days before the settlement date, by 3 p.m., the seller has to notify the buyer of the exact pool ꩲof mortgages included in the MBS. Allocation of specific mortgages to the traded securit༒y happens in this period before delivery, which is known as mortgage allocation.

Approximately 90% of 澳洲幸运5官方开奖结果体彩网:Freddie Mac, Fannie Mae, and 澳洲幸运5官方开奖结果体彩网:Ginnie Mae mortgage-backed securities trade on the TBA marketplace. This makes it the most important secondary market for mortgage securities. It is second only to the U.S. Treasury market in fixed-income trading volume and is subject to rule-making by the Security Indus💫tr☂y/Financial Market Association (SIFMA).

Mortgage Allocation Guideli𓆉nes aಞnd Non-TBA Trading

The value of TBA trades isn't known at the time of execution, so they are estimated instead. Therefore, the final allocation of mortgages is subject to variance between the actual and estimated amounts. There's a variance restriction imposed by the SIFMA. This restriction is a means to ensure the interchangeability of the underlying mortgages and is set at 0.01% of the price of the trade.

The mortgages that will be delivered on the settlement date must satisfy the agreed-upon trade within the boundaries of that requirement. In the past, variance limitations were more lenient and allowed traders an arbitrage opportunity when allocating mortgages at the notification date. As SIFMA has tightened its variance allowanc🌼es, this is less common. 💮Advanced software has allowed traders to satisfy tighter variance guidelines.

Traders looking to avoid the allocation process have the option of placing non-TBA trades in the specific pool market. In these transactions, the buyer and seller agree to trade particular 澳洲幸运5官方开奖结果体彩网:mortgage pools, and no subsequent allocation is required. The loans sold in this market tend to be of classes that don't meet SIFMA’s definition of standard loans. These can be 澳洲幸运5官方开奖结果体彩网:interest-only loans, 40-year mortgages, or 澳洲幸运5官方开奖结果体彩网:adjustable-rate mortgages (ARMs).

Example of a Mortgage Allocation

Max decides to sell Peyton an MBS, and Peyton decides to buy it. They both agree the sale will take place on Tuesday. When the sale is executed, neither Max nor Peyton knows the types of mortgages that make up the MBS. The standard settlement is T+3, meaning the trade will settle on Friday. Per the two-day rule, Max reaches out to Peyton on Wednesday before 3 p.m. and notifies them of the mortgage allocations they will receive when the trade settles on Friday.

The Bottom Line

Mortgage allocation refers to a process in which the seller of an MBS notifies the buyer of the details of the underlying mortgages that make up the MBS. The mortgage allocation process occurs in the secondary market for traded MBSs. The seller must inform the buyer of the underlying mortgage details by 3 p.m. two days before trade settlement.