The current coupon is a term used to describe a certain to be announced mortgage backed security with a current delivery month. The security that is trading closest to its par value without going over par is designated as the current coupon. A coupon is the interest payment on a loan, and current refers to an instrument that is at the going market rate. Taken together, this means that the current coupon mortgage backed security has the interest rate that most accurately reflects the current state of the market.
A mortgage backed security is a type of debt instrument issued by three entities: Fannie Mae, Freddie Mac and the Government National Mortgage Association, which is also called Ginnie Mae. These institutions take the money that investors pay for mortgage backed securities and use it to purchase residential mortgages. They form their mortgage holdings into pools, and the securities that they sell guarantee payments to the holders based on the payments made by the borrowers in the underlying mortgages. This allows investors to put funds into residential mortgages without directly negotiating with borrowers. Mortgage-backed securities are easily traded, so they form a secondary market for residential mortgages on which investors can trade the securities in ways that reflect their expectations about the future of the market.
The current coupon security must be a to be announced, or TBA, mortgage backed security. This qualification means that the pool of mortgages that will back the security has not been assigned, even though the contract is about to be made. This is because the mortgage backed security issuing agency can write new loans in between the time of the contract arrangement and the delivery date. The mortgages, however, will be fairly current because of the specification that the current coupon security must be delivered within the month.
To determine which security is the current coupon, it is necessary to know the par value of the mortgages. The par value is the sum of the outstanding principals on the underlying mortgages. With older securities, this can vary based on how many prepayments are made in a given pool. The mortgage backed security is TBA, so the mortgage pool, although still in the planning stages, is full: none of the borrowers have had a chance to prepay. This means that the par value of the security is a predetermined amount which the institution will meet by selecting mortgages with appropriate principal amounts.
The current coupon is of interest to investors because it reflects the state of the mortgage market. It accumulates all of the traders’ knowledge of mortgages to give a succinct report about what they think the fair rate for new mortgages should be. Lenders refer to the current coupon security’s interest rate for a baseline rate when they are writing mortgages.
