Mortgage Allocations

A process used in the settlement of mortgage-backed security to-be-announced (TBA) trades. This process requires that the sell side of a TBA trade inform the its buy-side counterpart of the exact securities that will be delivered into the trade by no later than 3 pm EST, and 48 hours prior to the established trade settlement date. In addition, each trade must be broken down into $1 million lots, and each lot can contain no more than three pools. A 0.01% variance is allowed on each $1 million lot. Most participants in the TBA market have software that helps them with mortgage allocations.

As the TBA market developed in the 1980s and 1990s, mortgage allocations were done manually or with limited software. The day 48 hours prior to major settlement days, known as "48 hour day", was a hectic and stressful day for TBA securities dealers and other market participants.

The allowed variance on TBA trades was initially much higher than the 0.01% it is today, and traders used this "allocation option" to make arbitrage profits. For example, if the current market price of a TBA trade was higher than the actual trade price, a trader could use the allowable variance to deliver a minimum amount into the trade, sell the difference at the current market price and realize the difference in prices on the dollar amount of the allowable variance as profit.

The exact opposite could be done if the trade price was higher than the current market price; the trader would deliver as much as allowed by the variance into the actual trade and purchase the difference in the current market at a lower price. The reduction in the allowed variance to 0.01% and the advent of sophisticated software has made mortgage allocation much less hectic than it once was.