--Amelia Granger
There is chatter in the agency mortgage-backed securities market this week that a fail penalty is coming soon to the government wrapped asset class. The proposed penalty on to-be-announced pools will aim to cut back on the number of agency trades that are negotiated, but not finalized.
The penalty on failed trades will likely be calculated as moving inversely to the rates environment, with a cap at 3%, according to a Morgan Stanley investor note out today. The U.S. Department of the Treasury will enforce fines when a trade has been contracted, but the seller fails to deliver the bonds.
The way it works now is a dealer will reimburse investors for incomplete trades, but desks are currently not penalized for the failure. A similar penalty was introduced to the Treasury market in late 2008, and TBA agency bonds can expect one “sooner rather than later” Janaki Rao, mortgage strategist at Morgan Stanley, told TS Monday.
“There’s really been no announcement per se,” Rao said. “But [the Treasury] said periodically that they’re working on a fail penalty.” His team took the view the penalty was imminent based on what sources in the market have been saying.
One agency MBS trader speaking with TS said he remembered the market exploiting loopholes. “Back in ’03 prepayments were in the 60s, 70s, 80s –it was cheaper to take delivery on the bond in the middle of the month so you could get a peek at the pool’s prepayment,” he said. “Then you could say next month, ‘Okay, you take some of those pools.’” The lack of a fail penalty meant dealers could arrange....