Mortgage Allocations Meaning Process Example

Mortgage allocations are a step in the settlement of mortgage-backed securities (MBS) traded in the secondary market. The seller provides the buyer with the precise details of the loans that make up the underlying pool of the MBS.

Key Takeaways:

– Mortgage allocation refers to a step in a mortgage-backed security (MBS).

– The seller notifies the buyer of all the details of the underlying mortgages.

– This process occurs in the secondary market for traded mortgage-backed securities (MBS).

– Neither the buyer nor the seller is aware of the underlying mortgages at the time of trade.

– The seller must notify the buyer of all underlying mortgage details two days prior to settlement by 3 p.m.

– There is a variance restriction value of 0.01% of the trade price.

Understanding Mortgage Allocations:

Mortgage-backed securities (MBSs) are financial securities created by pooling multiple mortgages and selling them to investors. Buyers of MBSs receive income from interest payments made by homeowners.

When MBSs are traded in the secondary market, the underlying mortgages are unknown. Mortgage allocation is the process where the seller of an MBS details the mortgages that make up the MBS by a certain date and time.

Mortgage Allocation Process:

Buyers and sellers agree to the terms of a TBA trade, including issuer, maturity, coupon, price, and par amounts. The underlying loans are interchangeable, and the quality is unknown.

The buyer and seller agree on the settlement date. Two days before settlement, the seller notifies the buyer of the pool of mortgages in the MBS. This period is known as mortgage allocation.

Approximately 90% of mortgage-backed securities trade on the TBA marketplace, making it the most important secondary market for mortgage securities. It is subject to rule-making by SIFMA.

Mortgage Allocation Guidelines and Non-TBA Trading:

The value of TBA trades is estimated, and the final allocation is subject to variance. SIFMA imposes a variance restriction of 0.01% of the trade price.

Mortgages delivered on the settlement date must satisfy trade requirements. Traders can place non-TBA trades in the specific pool market to avoid the allocation process. These trades involve non-standard loans.

Example of a Mortgage Allocation.