Mortgage market players mostly shrugged off the Chicago Board of Trade's (CBOT) announcement last week that it was launching a new mortgage futures market, mainly because previous attempts at creating such a market died from lack of interest and an extremely liquid to-be-announced (TBA) market already exists for mortgages.
"This is not a groundbreaking event for fixed income," said Michael Hoeh, an MBS money manager at Dreyfus Corp. "It is unlikely that a mortgage contract will be as liquid as the TBA market. It looks like the CBOT missed the point, that the MBS market trades on a TBA, which is liquid out for three months...and it is already not a problem to short collateral."
"This was attempted before, and there's a reason why nobody cared the last time around," added an MBS researcher. "Maybe this improves liquidity in the market at the margins, but I don't think it significantly impacts the market one way or the other."
Last week, the CBOT announced it would start trading a new Mortgage Futures contract beginning 3/2/01, based on Fannie Mae and Freddie Mac mortgage-backed securities. The contract will be listed monthly, with the nearest four months trading at any given time. The contracts will be quoted in points and quarters of 1/32s and have a face value of $100,000.
The new contracts are designed to focus on mortgage coupon levels at which issuance is heaviest and trading activity is busiest. The CBOT said the contracts will help increase liquidity in the mortgage securities market by giving mortgage originators, servicers, dealers and investors new and more effective risk-management tools.
"One possible advantage is that it might be easier for mortgage traders to actually trade options to hedge their portfolios," said a Street analyst. Right now, traders have two options: they can either trade Treasury futures options, which is not regarded as an effective surrogate, or buy mortgage/Treasury options in the over the counter (OTC) market. "And that is a pain. For the purposes of a trading desk it is miserable. So with the new mortgage futures, there might be a better convexity hedge."
"The U.S. mortgage-backed securities market is a large and rapidly growing market, and it is one of the biggest in the world without a futures market counterpart," said David Brennan, chairman of the CBOT, in a prepared statement.
Despite this highly touted launch, mortgage players insist that this type of futures contract has been tried before and was not successful.
"There have been several tries over the last quarter century to have a futures contract, and it never really worked," said Art Frank, head of MBS research at Nomura Securities. "And the reason is that the TBA is such a liquid forward market that it's not clear why people need a futures market."
One source recalled that a Ginnie Mae futures market had once existed, predating TBA trading. "It was a good competitor to the forward market, but a pain to settle. Nobody really used it as a means for actually trading. So contract volume went down, and it died from a lack of interest," the source said.
Advantages
According to Lehman Brothers, the primary advantage of the futures contracts is the potential leverage. It will also allow investors to short mortgage securities - a benefit to money managers who can underweight mortgages only by selling them.
The futures contracts will also allow banks and insurance companies the ability to underweight as well, and they will not have to sell, which results in recognition of gains and losses. This will not be the case with mortgage futures.
The largest potential users, suggests Lehman, is non-mortgage players who want to use the liquid MBS market as a spread hedge or for leveraging spread bets.
Lehman notes also that the duration and convexity of the index can differ from current coupons. In a rally, the index will become a premium and trade with a shorter duration and more negative convexity than currents, and vice-versa in a back-up.
