Failure to Deliver
Occasionally, sellers cannot provide pool information by the notification date or cannot deliver pools on the settlement date. Sometimes an originator must delay a delivery date with a dealer, or a dealer may not be able to cover a short position in TBAs. In these cases, a fail occurs.
All sellers have a strong economic incentive to deliver pools as soon as possible because buyers pay only the amount agreed to plus accrued interest through the original settlement date, and they do not pay until the securities are delivered. In the meantime, the buyer can invest the funds at short-term rates. A seller that delivers pools after the record date also must advance monthly payments to buyers. Buyers who are particularly averse to fails sometimes request settlement after the official settlement date. By giving the dealer more time to assemble appropriate pools, the buyer further minimizes the possibility of a fail.
These good delivery guidelines were established because of certain unique characteristics of the mortgage market. In part, they help mortgage originators manage their mortgage pipelines more efficiently by defining widely accepted criteria under which mortgage securities can be sold and traded generically. As noted earlier, mortgage originators can hedge pipeline risk by selling mortgage securities that do not yet exist into the forward market based on expectations that loans in the pipeline will close and be securitized by the settlement date.
These guidelines also help facilitate trading activity in other ways. Amortization and prepayment of mortgage pools mean that securities rarely will have current face values in convenient multiples of $1,000, making the good combo and variance rules essential both for combining awkward pools or securities and for ensuring that buyers are not forced to accept delivery of a large number of splintered pools. The notification rule gives the parties to a trade time to prepare for settlement and ensure that the trade goes smoothly.
Although most TBA trades conform to the BMA guidelines, trades can be negotiated to settle in whatever fashion is satisfactory to both the buyer and the seller. For example, two parties may agree to trade a TBA security on any day of the month. They also could agree to change the amount of variance or allow no variance at all.
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