Success With TBA Trading: Managing Counterparties, Executing Efficiently and Avoiding Pitfalls

Published July 1, 2022

Whether you’ve just made the move to delivering mandatory, or you’ve been hedging and delivering mandatory for years – it’s always worthwhile to stop and consider your TBA trading strategies, processes and counterparties. While each lender is unique, all of us are aiming to trade for optimal execution and minimal risk. It’s essential to build and maintain a roster of dealers who facilitate maximization of liquidity, execution and flexibility.

Selecting Dealers and Managing Relationships

Before trading, consider whether you’re working with the best possible set of dealers. In general, there are two types of dealers who work with mortgage banks:

• Regional brokers: Offer great liquidity and flexibility; can often provide credit to lenders of any net worth
• Primary dealers: Often banks or investment banks that require a higher net worth; may provide higher average price levels, because their perceived counterparty risk is lower, and they are likely to be working with larger trades

Some lenders are limited in the variety of dealers they can use, while others have more options. Your capital markets team should confer with your advisor and consider the items below when choosing dealers. The Optimal Blue account management team also discusses these topics with clients periodically to help them maximize their TBA management and trading program effectiveness.

Considerations when choosing dealers:

• Net worth: Every dealer requires a minimum net worth, which varies by dealer. Regional brokers often work with lenders with equity as low as $2 million, whereas primary dealers require, $7 million, $15 million or more than $20 million.
• Whether the lender is selling pools: Some dealers offer far more liquidity for pool sales, while others are more focused on TBA business. If the lender is selling pools, it’s best to build a stable of regional brokers who have a deep list of third parties looking to buy certain types of pools. A few primary dealers are also recommended to round out the roster.
• Electronic trading: Most primary dealers can trade with a lender or hedge advisor via Tradeweb or Bloomberg. In this context, electronic trading can be a great tool to make the process faster, more accurate and even to increase execution. A growing number of regional brokers are joining this trend. There are also some dealer-specific portals that have come online recently, which can be an excellent supplement to phone trading. If choosing a third-party platform, the key is to avoid a platform that may limit the selection of counterparties available to you, and/or that charges substantial fees to you or your broker-dealers.
• Risk tolerances: Consider how much risk you are willing to associate with a given counterparty. It may be necessary to increase the number of counterparties to reduce the per-dealer outstanding trade amount.

Now that you’ve considered which dealers are in scope for your needs, let’s discuss counterparty relationships. Some dealers may be more flexible than others when you need something – such as an after-hours trade, an extension on your line or a margin call consideration. Remember, like any counterparty, your dealers should be partners.

As a general guideline, high-net-worth lenders will work with four to six primary dealers, and three to five regional brokers, all with a track record of strong liquidity and pricing. Lower-net-worth lenders, on the other hand, will want to focus on four to six regional brokers, and one or two primary dealers who will work with lower equity, if possible.

Strategies for Most Efficient Execution

Now, we trade! But first, it is important to determine how we can maximize execution with our selected dealers.

Strategies to employ:

• Combining transactions: This concept is often overlooked by novice traders, but can lead to significant efficiency gains. When executing any trade, it is wise to consider what other position changes may be needed. For instance, if lifting coverage after a loan sale, perhaps there are also trades that need to be rolled. Or, when rolling coverage to a new month, there may be an opportunity to swap to a new coupon as well.
• Trading in competition: Regularly placing trades in competition is a great way to keep your dealers sharp. Platforms such as Tradeweb and Bloomberg can simplify this process, but it can also be done by phone or by a combination of phone and portal trading. Your advisor will employ one or more of these techniques if they are trading for you.
• Trading often – but not too often – and setting yourself up for new production: Often, it’s inefficient and unnecessary to trade for each loan that comes into the pipeline, but it’s also unwise to trade only a couple times per day. For most lenders, it makes sense to think about these concepts throughout the day:
  • At market open: This is a good time to review overnight changes for any adjustments needed, but evaluate and consider estimated new lock volume for the day
  • When publishing initial pricing for the day: At this point, the market has usually settled, and you are preparing for incoming lock volume. Based on expectations and historical data, a trade to cover X% of new locks can be completed.
  • Monitoring throughout the day: Frequently, as loans are imported into the position, we review and readjust as needed. It’s important to talk with your hedge advisor to get a feel for your optimal trade size range.
  • When committing loans and assigning trades (AOTs): Always consider what material changes may occur to your pipeline. Any time you are selling a group of loans, be sure to communicate closely with your hedge advisor and/or your internal team, to ensure trades are lifted/rolled in close time with when bids are hit, and always look for opportunities to assign trades.
• Spread exposure across dealers: Of course, you will want to hit the best price almost every time, but ties are common. In tie situations, look to spread volume around. This will keep your dealers on their toes and will also keep margin exposure more evenly distributed.

These are just a few strategies that you can discuss internally and with your advisor to achieve the most efficient execution.

Pitfalls to Avoid

By leveraging these strategies  and staying in close contact with dealers and advisors, you’ve already mitigated much of your risk. However, there are still pitfalls to avoid.

Issues to watch out for:

• Running out of liquidity: If volume is sharply increasing, or changes in your business model require more dealer capacity, get ahead of it. If you’re using over 60% of your open trade lines, you should be adding capacity with existing dealers, or re-evaluating your stable and adding new counterparties.
• Too much capacity: Especially in slow markets, dealers may look to build in more spread on trades if you don’t trade with them often enough. Their time and their capital is worth money to them. If you find that you mainly trade with only five of your six dealers, consider eliminating or replacing the sixth one.
• Third-party fees: You may or may not be able to see these fees. Watch for inferences or outright evidence that you or your dealers are being charged anything more than a few dollars to execute a trade.
• Margin and broker dealer exposure: It’s not too far in our rearview mirror, but many folks have scars from the market whipsaws from the effects of the COVID-19 pandemic in 2020. Many lenders had to deal with large margin calls that were triggered by the volatile market. You should brush up on all the margin and trade mark-to-market requirements. This is another reason to have a stable of dealers and to spread trades across them when possible. Right now, cash is too important.

Success Requires an Ongoing Commitment

This simplified guide is meant to get you thinking about the ongoing project of maintaining the right counterparty mix and trading efficiently, while avoiding unnecessary friction or risk along the way. Remember: you should discuss these points with your hedge advisor, because every lender is different, and the market is constantly changing. Nothing herein shall be construed as, nor is Black Knight providing, any legal, trading, hedging or financial advice.