Practical Applications of Primer on Agency Mortgage-Backed Securities Specified Pools and Their Convexity Profiles

Abstract

In Primer on Agency Mortgage-Backed Securities Specified Pools and Their Convexity Profiles from the Spring 2022 issue of The Journal of Fixed Income, authors Glenn M. Schultz (of MUFG Securities) and Frank J. Fabozzi (of Johns Hopkins University and EDHEC Risk Institute) describe the various sectors of the market for agency mortgage-backed securities (MBS) specified pools. While most MBS are traded on a generic basis—without identifying the underlying pool of mortgage loans—some trades specify the particular underlying pool of the security that must be delivered to clear the trade. The first type of trade is called a to-be-announced (TBA) trade, and the second type is called a specified-pool trade.

When market participants trade agency MBS on a specified pool basis, they generally do so because they expect the loans in the underlying pools to display atypical prepayment behavior, which gives the related MBS atypical convexity properties. Specified pools are categorized into sectors, based on loan balance, loan-to-value (LTV) ratio, and geographical location, plus whether they consist of refinanced mortgages or mortgages for investment properties, relocating employees, or people with suboptimal credit scores. The authors describe each specified-pool sector and its convexity profile. Most have positive convexity relative to generic pools and trade at a premium, but jumbo and relocation mortgage pools have negative convexity relative to generic pools and trade at a concession. Investors can manage risk by allocating assets to customize the convexity profiles of their MBS portfolios.