The New York Federal Reserve will engage in coupon swaps to help facilitate the delivery of approximately $9.2 billion in currently unsettled FNMA 5.5% pools, the regulator announced this morning.

Under the plan, it will swap unsettled FNCL 5.5s for other, more readily available coupons. It plans to begin operations on June 29, and does not expect to exceed the $9.2 billion target.

According to Barclays Capital analysts, the decision reflects the fact that FNMA 5.5s are in short supply and the Fed might be having difficulty taking physical delivery of these bonds.

The Fed’s data showed that there was $11.2 billion of FNMA 5.5s scheduled for April settlement, but it appears that counterparties have not delivered these securities and have forced the Fed to roll them. Selling these securities into the market and moving into other coupons may make it easier for the Fed to take delivery of all of their outstanding purchases, Barclays analysts said.

The firm said that 4.5s are the most logical choice for a Fed swap because float is greatest in this coupon and new origination is also predominantly concentrated in FNMA 4.5s. Since the central bank ultimately seeks to reduce its MBS holdings partly through paydowns, increasing exposure to longer coupons does not make much sense, so swapping for 5s appears unlikely to Barclays analysts. They estimated that as much as 24-32 ticks of the dollar price of FNMA 5.5s reflects a lack of available float.

“If [the Fed] wants to alleviate MBS liquidity issues (as it has committed to), the logical next step would be to offer up bonds for delivery in coupons that have no float, with 5.5s being the prime example,” Barclays analysts said. “As most investors start to worry about this possibility, 5.5s should underperform further.”

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