The Single Security is a joint initiative of Fannie Mae and Freddie Mac (the Enterprises), under the direction of Federal Housing Finance Agency (FHFA), to develop a common mortgage-backed security that will be issued to finance fixed-rate mortgage loans backed by one to four-unit single-family properties. The Enterprises will align key components of Fannie Mae’s mortgage-backed securities (MBS) and Freddie Mac’s Participation Certificates (PCs). The goal is to bring additional liquidity and fungibility to the “To-Be-Announced” (TBA) market and to reduce or eliminate the trading disparities that exist today between the Enterprises’ TBA securities.


BBH Aproach

BBH is actively engaged with industry conferences and forums (SIFMA, ICI, ISITC, etc) to understand and assess readiness for the Single Security initiative. There is some operational complexity surrounding the processing of this exchange event and the impacts can be seen across the realm of Custody, Fund Accounting, Fund Administration and Tax. We will work to ensure that our clients are aware of the Single Security initiative and collaborate with them to ensure we are taking into account key considerations that may create an impact.

Highlights

  • Implementation date is June 3rd 2019; Enterprises will begin issuing new Uniform Mortgage-backed Securities (UMBS)
  •  Freddie Mac began issuance of mirror securities on August7th, 2018 and has slowly ramped up to a steady state of about 5,000 per day (~70,000 securities total). Exchange starts in May 2019 and there is no formal end to the ability to convert
  • Fannie Mae and Freddie Mac will orchestrate an industry tabletop testing exercise (Q4 2018); two working sessions to identify scenarios and address detailed questions have been held
  • Following an extensive analysis and feedback period, Freddie Mac has made the decision to offer investors two operational paths for Gold PC and Giant PC exchanges. A corporate actions path was evaluated but was rejected due to the fact that The Federal Reserve, which is where these securities are custodied, does not support reorganization events within the industry. Thus, the two trade-driven paths are as follows:
    • The broker-dealer facilitated exchange path is complete and broker-dealers are already using the web-based portal for Giant transactions today. The trade instruction to the Custodian will be DVP/RVP
    • The direct to Freddie Mac exchange path with Tradeweb is being finalized. The trade instruction to the Custodian will be Free Del/Free Rec. Expected to be open for 3 – 5 years 
  • The SIFMA Asset Manager’s Group Custodian Committee has developed a recommended ISITC formatted trade instruction for the broker-dealer facilitated path
  • Freddie Mac will compensate securities holders for the10 days’ difference in payment delay between the two securities – Float Compensation

Overview of Exchange

  • Investors will be able to exchange 45-day PCs for 55-day mirror securities ultimately backed by the same pool of loans. Items to note relative to the exchange include:
  • Open to holders of both TBA and non-TBA PCs
  • Exchange will be at the option of holders; not mandatory
  • Freddie Mac will not charge an exchange fee
  • Freddie Mac, jointly with Fannie Mae and FHFA, sought advice from the IRS and SEC on the tax and accounting implications of exchange
    • The SEC has said that they have no objection to FHFA’s proposed treatment of the exchange as a minor modification
    •  IRS Revenue Ruling 2018-24 published August 17th concluded that the exchange of 45-day Gold PC securities for 55-day Freddie Mac mortgage-backed securities will not be taxable
    • The IRS did not rule on the tax treatment of the cash compensation
  • Freddie Mac will treat the float compensation payment as a tax-free adjustment to the security basis. As such, for those investors that execute their exchange through the direct-to-Freddie path, Freddie Mac does not intend to report the payment as taxable income to the investor.

Timeline
Implementation of these changes will occur in Q2 of 2019 and forward trading for future settled securities may begin as early as Q1 2019.

Considerations
In discussions with Industry representatives, each affected market participant will need to consider:

  • Impact to systems and workflow processes; including how Fund Administrators will be instructed for accounting purposes
  • Approach & workflow specific to security exchanges
  •  Exchanged securities will also require “float compensation” as a component to align security features
  • Portfolio issuer concentrations
  • Impact to forward trading and mortgage dollar rolls

Additional Resources
http://www.freddiemac.com/mbs/html/single_security_csp.html

For more information, please contact your relationship manager.

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