FIXED INCOME

April 2014

ANALYST INSIGHTS

TBAs and Forward Contracts: A Useful Tool in

Fixed Income Portfolio Management
Agency mortgage-backed securities (MBS) are an important
component of many fixed income portfolios, and a key strategic
element of most Galliard portfolios. The market for MBS
is very large and very liquid, but also has some distinctive
characteristics. One of the distinguishing characteristics of the
MBS market is the heavy emphasis on forward settling issuance.
The to-be-announced (TBA) market and forward settling MBS
More than 90 percent of agency MBS trading volume occurs in the forward
market, which is known as the TBA (to-be-announced) market. In a TBA
trade, the seller of MBS agrees to a sale price, but does not specify which
particular securities will be delivered to the buyer on settlement day. Instead,
six basic characteristics of the securities are agreed upon: issuer (eg. Freddie
Mac), maturity (eg. thirty year), coupon (6%), price ($102), par amount
(eg. $200 million), and settlement (eg. August). The TBA trading convention
improves market efficiency, offering benefits to issuers, as well as buyers of MBS.

www.galliard.com
800 LaSalle Avenue, Suite 1100
Minneapolis, MN 55402-2054

More than 90% of agency

MBS trading volume occurs in
the forward market. Galliard
utilizes TBA securities as part
of its overall diversification/
risk mitigation strategy for
managing fixed income
portfolios.

Client Aligned
Investment Solutions

TBA Dollar Rolls

TBA trading has also led to the
development of a funding mechanism unique to agency MBSthe
dollar roll. A dollar roll is simply the
combination of one TBA trade with
simultaneous and offsetting TBA trade
settling on a different date. This transaction is also commonly referred to as
a pair off (see Table 1) This mechanism allows investors and market

makers great flexibility in adjusting

their positions for either economic or
operational reasons1.
Galliard enters into TBA dollar
rolls when the pricing in the TBA
market is attractive relative to the
market for specified pools. The typical
exposure for Galliards TBA dollar roll
strategy is between 0-5%. In general,
our TBA strategy can be expected
to generate 2550 basis points of

annualized excess return on the trade,

which translates into up to 23 basis
points of alpha on an annual basis at
the portfolio level.2

A dollar roll is simply the

combination of one TBA
trade with simultaneous and
offsetting TBA trade settling
on a different date.

Table 1 // An Example of a Dollar Roll Pair Off

Dollar Roll: Purchase
Portfolio Transactions (Period: 11/01/2013-12/31/2013)
CUSIP

Security Description

02R0304C4

FGCI 15-YR 3.0 FGLMC TBA

02R0304C4

FGCI 15-YR 3.0 FGLMC TBA

Par Amount

Price

Trade Date

Settle Date

Flt DUE 11/01/2028

1,800,000

102.67

11/12/2013

12/17/2013

Flt DUE 11/01/2028

1,800,000

102.46

12/11/2013

12/17/2013

Purchases
Mortgage Backed
Sales
Mortgage Backed

In the case of the dollar roll purchase, the TBA purchase (CUSIP 02R0304C4) is initiated on 11/12/13 for settlement
on 12/17/13. Before settlement, the same TBA was sold (on 12/11/13 in this example), offsetting the initial position.
These trades are netted out and settled via payment. In this case, a capital loss was realized on the trade. Between
trade date and settle date, CUSIP 02R0304C4 shows up on the Galliard holdings statement with a par amount of
$1.8 million.

Dollar Roll: Sale

Portfolio Transactions (Period: 10/31/2013-12/31/2013)
CUSIP

Security Description

01F0326C3

FNCL 30-YR FNMA TBA

01F0326C3

FNCL 30-YR 3.5 FNMA TBA

Par Amount

Price

Trade Date

Settle Date

Flt DUE 12/01/2043

3,000,000

100.78

11/21/2013

12/11/2013

Flt DUE 12/01/2043

3,000,000

100.38

12/03/2013

12/11/2013

Sales
Mortgage Backed
Purchases
Mortgage Backed

In the case of the dollar roll sale, the TBA sale (CUSIP 01F0326C3) is initiated on 11/21/13 for settlement on
12/11/13. Before settlement, the same TBA was purchased (on 12/11/13 in this example), offsetting the initial
position. These trades are netted out and settled via payment. (In this case, a capital gain was realized on the trade.)
Between trade date and settle date, CUSIP 01F0326C3 shows up on the Galliard holdings statement with a par
amount of negative $3.0 million.

1.
2.

Vickery James and Wright Joshua, TBA Trading and Liquidity in the Agency MBS Market, FRBNY Economic Policy Review / May 2013
Estimate based on assumed average allocation to TBAs of 3% and a return advantage (net price drop and financing advantage) of 0.125% per quarter for TBA dollar roll transactions.
Estimates are based on Galliard historical experience and are for illustrative purposes only. Past performance is no guarantee of future results. Individual client experience will vary.

| Fixed Income Analyst Insights . April 2014

Delayed Settlements
Another strategy used by Galliard
in both the residential MBS market
and the commercial MBS (CMBS)
market is forward purchase agreements with delayed settlement (Table
2). These holdings are not TBAs, but
are displayed on Galliard reports as
GTBAs, reflecting their similarity.
Unsettled forward purchase agreements will typically make up 2-5% of
a portfolio at any given point in time.

Delayed settlements are not TBAs

but are similar.

However, unlike TBA dollar rolls,

forward purchases are an acquisition
strategy, and the bonds acquired via
forward purchases accumulate over
time and may make up 15-20% of a
portfolio.

Certain sectors of the MBS market,

such as FNMA DUS, 10-year MBS
pools, or GNMA HECMs are only
available in the forward purchase
market. The impact of not being able
to utilize forward purchase agreements
could cost a portfolio 10-15 basis
points of annualized alpha.3 Perhaps
as important, prohibiting forward
purchase agreements would inhibit the
ability to diversify portfolios further, a
key risk mitigation strategy for Galliard.

Table 2 // An Example of a Delayed Settlement

Delayed Settlement: Purchase
Portfolio Transactions (Period: 08/1/2013-11/30/2013)
CUSIP

Security Description

GTBA402$1

FNCN 10-YR 3.0 2013 FNMA

POOL MA 1691

Par Amount

Price

Trade Date

Settle Date

50,000

102.75

08/15/2013

11/18/2013

Purchases
3.00% DUE 12/01/2023

In the case of the delayed settlement purchase, the purchase (CUSIP GTBA402$1) is initiated on 08/15/13 for
settlement on 11/18/13. Between trade date and settle date, CUSIP GTBA402$1 shows up on the Galliard holdings
statement with a par amount of $50,000. Two business days before the settle date, the CUSIP of the security to be
delivered is disclosed as 31418A2Z0. The new CUSIP replaces the GTBA cusip on the Galliard holdings statement.

Delayed Settlement: Sale

Portfolio Transactions (Period: 10/31/2013-12/31/2013)
CUSIP

Security Description

01F0304C9

FNCI 15-YR 3.0 2012 FNMA

POOL AK9074

Par Amount

Price

Trade Date

Settle Date

1,400,000

102.95

11/12/2013

12/17/2013

Sales
Mortgage Backed

3.00% DUE 04/01/2027

In the case of the delayed settlement sale, the sale (CUSIP 01F0304C9) is initiated on 11/12/13 for settlement on
12/17/13. Between trade date and settlement date, CUSIP 01F0304C9 shows up on the Galliard holdings statement
with a par amount of negative $1.4 million. Two business days before the settle date, the CUSIP of the security to be
delivered is disclosed as 3138EECL1. The new CUSIP replaces the old cusip on the Galliard holdings statement.

3.

Estimate based on 1) assumed 10-15% position in assets acquired via forward settlement process and a 25bps return advantage on these securities versus generic MBS; and 2) assumed
5% higher allocation to MBS sector versus accounts that cannot acquire securities via forward settlement transactions and a 50bps return advantage over US Treasuries for these securities.
Estimates are based on Galliard historical experience and are for illustrative purposes only. Past performance is no guarantee of future results. Individual client experience will vary.

www.galliard.com

Guideline Implications

FOR MORE
INFORMATION
Galliard Capital Management
800 LaSalle Avenue, Suite 1100
Minneapolis, MN 55402-2054
800-717-1617
Carrie Callahan
Managing Partner
carrie.a.callahan@galliard.com
612-667-1793

Some investment guidelines restrict the use of derivatives, including forward

contracts. Typically, this restriction is intended to prevent leveraging of the
portfolio, or other high-risk strategies. However, it has the effect of limiting the
use of TBAs, dollar rolls, and even forward settling purchases that are common
practice in conventional fixed income portfolios. This unintended consequence
is generally overcome by excluding TBAs and forward settling MBS from the
restriction via an amendment or side letter to the investment guidelines.
Alternatively, TBAs may be prohibited, but forward settling MBS allowed
using language such as the following:
TBA means a contract for the purchase or sale of Agency RMBS or Agency
CMBS to be delivered at a future agreed-upon date entered into as a derivative
transaction to manage credit exposure. For the avoidance of doubt, this definition
of TBAs shall not include forward purchase agreements with delayed settlement
which the investment manager may enter into as part of the investment managers normal practice of purchasing newly issued Agency RMBS or Agency CMBS.

Taylor Benson
Senior Director
taylor.benson@galliard.com
612-667-4252
Find additional research pieces on
www.galliard.com
Galliard is an independently operated
subsidiary of Wells Fargo Bank,
N.A. specializing in fixed income
and stable value management for
institutional investors. Founded in
1995, Galliard manages more than
$85.0 billion (as of 1/31/14).

Reporting and Audit Considerations for TBAs and Forward Settling MBS
Notwithstanding their broad usage, TBAs and forward settling MBS may still
create confusion in client reporting and audit situations.
What helps clarify this is the fact that TBA trades follow the same good
delivery guidelines set forth by the Securities Industry and Financial Markets
Association (SIFMA), an industry trade group whose members include
broker-dealers and asset managers.4 These guidelines establish a timeline for
TBA trades with delayed settlement as follows:
Trade Day: Buyer and Seller agree on six standard trade parameters
Two Days Before Settlement: Seller provides buyer with identity (and CUSIP) of
pools intended for delivery on settlement day
Settlement Day: Seller delivers security specified two business days prior
For both purchase and sale transactions, Galliard executes dollar roll and
delayed settlement transactions. For illustrative purposes, Tables 1 and 2 show
each transaction type and how their transactions appear on Galliards standard reporting.

4.

Vickery James and Wright Joshua, TBA Trading and Liquidity in the Agency MBS Market, FRBNY Economic Policy
Review / May 2013

The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable
by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and
there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any
time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a
recommendation for a particular security strategy or investment product.
FOR INSTITUTIONAL INVESTOR USE ONLY.
2014 Galliard Capital Management, Inc.
FIAI040214
4

| Fixed Income Analyst Insights . April 2014