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5.6 Dollar rolls
Publication date: 30 Sep 2020
us Transfers of financial assets guide
Various transactions or sets of transactions are commonly referred to as "dollar rolls." Depending upon the facts and circumstances, certain dollar rolls are reported as repurchase agreements, while others are considered to involve derivative contracts. In certain instances, the transfer of the underlying securities may qualify for sale accounting, accompanied by the recognition of a derivative. By definition, dollar rolls involve a sale of securities accompanied by a commitment on the part of the transferor to subsequently purchase securities from the counterparty that are similar – but not identical – to the securities sold. The securities transferred and required to be repurchased are typically mortgage-backed securities (MBS) issued and/or guaranteed by the Government National Mortgage Association or government-sponsored enterprises (Freddie Mac and Fannie Mae).
The accounting for dollar rolls depends upon various factors, including the form of the transaction, judgments regarding whether securities to be repurchased will be substantially the same as those initially transferred, and whether the securities to be repurchased exist at the initial exchange date, or instead consist of securities to-be-announced ("TBA securities") before settlement of the transaction.
The ASC Master Glossary defines dollar rolls.
Definition from ASC Master Glossary
Dollar-Roll Repurchase Agreement: An agreement to sell and repurchase similar but not identical securities. The securities sold and repurchased are usually of the same issuer. Dollar rolls differ from regular repurchase agreements in that the securities sold and repurchased have all of the following characteristics:
- They are represented by different certificates.
- They are collateralized by different but similar mortgage pools (for example, conforming single-family residential mortgages).
- They generally have different principal amounts.
Fixed coupon and yield maintenance dollar agreements comprise the most common agreement variations. In a fixed coupon agreement, the seller and buyer agree that delivery will be made with securities having the same stated interest rate as the interest rate stated on the securities sold. In a yield maintenance agreement, the parties agree that delivery will be made with securities that will provide the seller a yield that is specified in the agreement.
ASC 860-10-20 also categorizes (as "types") various dollar rolls that involve mortgage-backed securities typically issued (or to be issued) by the Government National Mortgage Association.
Definition from ASC Master Glossary
Government National Mortgage Association Rolls: The term Government National Mortgage Association (GNMA) rolls has been used broadly to refer to a variety of transactions involving mortgage-backed securities, frequently those issued by the GNMA. There are four basic types of transactions:
- Type 1. Reverse repurchase agreements for which the exact same security is received at the end of the repurchase period (vanilla repo)
- Type 2. Fixed coupon dollar reverse repurchase agreements (dollar repo)
- Type 3. Fixed coupon dollar reverse repurchase agreements that are rolled at their maturities, that is, renewed in lieu of taking delivery of an underlying security (GNMA roll)
- Type 4. Forward commitment dollar rolls (also referred to as to-be-announced GNMA forward contracts or to-be-announced GNMA rolls), for which the underlying security does not yet exist.
5.6.1 Accounting for dollar rolls
The Master Glossary’s enumeration of GNMA dollar rolls provides a useful framework when determining the appropriate accounting for these transactions more generally. Type 1 is simply a repurchase agreement entailing a GNMA MBS. Although it may be referred to as a dollar roll, the transaction involves a conventional repurchase agreement. Accordingly, the transfer of the MBS will not meet the criteria for sale accounting in ASC 860-10-40-5.
A Type 2 dollar roll arises when a reporting entity transfers an existing MBS from its inventory and simultaneously agrees to repurchase a similar (but not identical) security in the future. As with any repurchase agreement, the transferor should evaluate first whether it has maintained effective control over the underlying security. For this condition to be met, the security to be repurchased or redeemed must be "substantially the same" as the transferred security, based on the criteria in ASC 860-10-40-24. Because the security sold and required to be repurchased in a Type 2 dollar roll may be similar but not identical, careful analysis of the terms of the repurchase agreement is necessary to determine whether the transferor has, in fact, maintained effective control over the MBS sold. If it is determined that the securities involved are not substantially the same, de-recognition of the transferred MBS is appropriate only if the remaining two conditions in ASC 860-10-40-5 are satisfied. Assuming the transaction qualifies for sale accounting, the commitment to repurchase the not-substantially-the-same MBS typically will meet the definition of a derivative.
A Type 3 dollar roll is essentially the same as Type 2, with one noteworthy exception; namely, as the contractual repurchase date nears, it is anticipated that the parties will, by mutual consent, extend this date, thus "rolling" the repurchase date to a future point in time. To achieve this, the parties enter into a commitment that offsets the current commitment to repurchase a security, and contemporaneously execute a new commitment that specifies a new (extended) repurchase date.
Although the "rolled" commitment to repurchase an MBS does not involve a transfer, the parties should ensure that new contract’s terms continue to support the assertion that the security to be repurchased is (or is not) substantially the same as the MBS initially sold. If not, additional analysis is warranted to determine whether the dollar roll’s initial accounting characterization remains appropriate.
A Type 4 dollar roll involves contracts requiring delivery of to-be-announced (TBA) MBS. The distinguishing feature of these contracts is that the identity of the MBS to be delivered at settlement is not specified at the trade date. Rather, the parties agree only on six characteristics of the MBS to be delivered: the issuer, par amount, maturity date, coupon rate, and price.
In certain instances, a TBA forward contract may cite additional characteristics ("stipulations"), for example, the geographical composition of the underlying loan collateral. In addition, participants in the TBA market generally observe market-practice standards (commonly referred to as "good-delivery guidelines") established and maintained by the Securities Industry and Financial Markets Association.
These conventions and contractual terms narrow the securities eligible to be delivered at settlement, and facilitate determining whether MBS to be delivered in future are likely to be substantially the same as the MBS securities sold.
Typically, two contracts having TBA MBS as an underlying are executed simultaneously. One contract will obligate the reporting entity to deliver (sell) a TBA MBS to a counterparty at a future date. At the same time, the reporting entity will contract with the same counterparty to acquire from it a TBA MBS, albeit at a different future date. The interaction between the two contracts’ settlement dates will depend on the reporting entity’s trading strategies, hedging objectives, and other commercial considerations.
A Type 4 dollar roll may not involve a financial asset recognized on the transferor’s balance sheet, as the underlying MBS obligated to be delivered at settlement may not yet exist or, if the securities do exist, the transferor does not necessarily own them at the trade date. Furthermore, the transferor may intend to offset its obligation to deliver MBS by subsequently entering into another TBA contract to purchase equivalent securities having the same settlement date. Indeed, in many instances, participants that utilize TBA MBS dollar rolls do so for hedging and financing purposes, and intend to net settle their positions using offsetting contracts. Accordingly, in these cases, the guidance in ASC 860 does not apply. These transactions should be accounted for consistent with the guidance in ASC 815, Derivatives and Hedging.
Other transactions involving the sale of MBS and a contemporaneous commitment to purchase MBS may be considered to constitute a dollar roll. For example, a reporting entity may transfer (sell) an existing MBS and simultaneously enter into a long forward contract involving TBA MBS with the same counterparty. As noted above, forward TBA contracts do not identify the specific securities required to be delivered. Accordingly, the TBA feature may complicate the transferor’s determination whether it will be acquiring MBS that will be substantially the same as the securities sold. Thus, similar to Type 2 dollar rolls, careful analysis and judgment is warranted.
In many cases, MBS TBA contracts are executed on an exchange that net settles transactions, such as the Mortgage Backed Securities Division of the Fixed Income Clearing Corporation. As such, a reporting entity’s settlement with an exchange may represent only the net impacts of a wide array of contracts settled that day. Securities delivered or received may represent only the incremental difference between long and short positions having the same underlying that were entered into at various points in time. Certain contracts may stem from speculative trading strategies; others may have arisen from any of the dollar roll transactions described above. Accordingly, net settlement protocols may introduce operational complexities that complicate a reporting entity’s assertion that MBS received are, in fact, substantially the same as those initially transferred.
1 In accordance with industry practice, two business days prior to settlement, a seller of the TBA MBS communicates to the buyer the details of the MBS pools that it intends to deliver.
2 See ASC 860-10-40-24(a)(6) for these guidelines.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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