Online mortgage bond exchanges are finally gaining traction in the mortgage-backed securities market, thanks to the growing support of a community they were once expected to kill off Wall Street dealers.
Only about a quarter of MBS trades in the first half of this year were done online. But the growth of TradeWeb LLC, a bond marketplace founded in 1997 by a group of institutional investors, shows that Wall Street is taking more to Web trading while at the same time defending its own role in the mortgage-backed securities market.
Last year Internet bond marketplaces located far from lower Manhattan such as Visible Markets Inc. of Boston and Pedestal Inc. of Washington got a leg up on Wall Street in the race to take mortgage securities trading online. By doing so, they threatened the profits of traditional MBS traders.
For the most part, traders still connect buyers and sellers of the bonds through fax and phone. This gives the traders a huge advantage in defining the spreads for these transactions, because the buyers and sellers usually dont know what the other is offering or willing to pay.
By contrast, the online trading sites tout their transparency bids are openly displayed, and sellers can accept the best one.
TradeWeb announced last month that it had signed up three new dealers for its to-be-announced mortgage-backed securities platform Bear, Stearns & Co., Royal Bank of Scotlands Greenwich Capital, and UBS Warburg. The additions will make TradeWeb the dominant force of TBA securities, which are the most liquid sector of the MBS market, the company said.
TradeWeb, which is partly owned by Morgan Stanley Dean Witter & Co., also offers platforms for Treasuries, agency debt, and commercial paper. Sixteen dealers now use its platforms, including 10 of the industrys largest market-makers, which use the TBA-MBS platform, the New York company said.
Our liquidity pool just got deeper with the addition of these three major TBA-MBS dealers, said Jim Toffey, TradeWebs chief executive officer. We expect to see more trading volume as a result.
There are two categories of mortgage-backed securities: the highly liquid to-be-announced securities and the less-liquid structured ones.
Pedestal is the only company other than TradeWeb that conducts online TBA trading. (A Pedestal spokesman declined to comment on the TBA market for this article, except to say that the company planned to make an announcement next month about the business.) By contrast, nearly a dozen companies conduct structured MBS trading on the Internet.
Experts say the addition of the three dealers to TradeWebs TBA-MBS platform demonstrates that Wall Street firms specializing in mortgage-backed products are seeing online exchanges in a new light; they accept them where they were once uneasy about them. This change is crucial, they say, because the online exchange industry is learning that its future as well as that of the MBS market in general still lies squarely in the hands of debt dealers.
Dealers have gone through an adjustment period, said Brian Robertson, the chief executive officer of Visible Markets, an online marketplace for fixed-income products. In 1999 and 2000 dealers were threatened by online exchanges, but the 2001 thinking has it that dealers have accepted it as a good thing and are using it to enhance their business, he said.
George Ostendorf, a senior managing director of Hanover Capital Mortgage Holdings Inc., the New York real estate investment trust that operates the online whole-loan exchange HanoverTrade.com, said Wall Streets previous reluctance to use the Internet was a turf issue.
Wall Street had an exclusive relationship for a long time with buyers and sellers, and they perceived the Internet as potentially standing in the way of that exclusive relationship that they have enjoyed, he said.
Also, Jack Mahoney, a managing director at Greenwich Associates, a Connecticut financial consulting firm, said some dealers feared that online exchanges would cut into their trading profits by providing institutions with more access to pricing information.
If you are a sell-side firm, you are not going to want more transparency, he said. It is counterintuitive for some of the traders on the Street. Why would I want this kind of information to go out? It could cut into spreads, theyre saying.
However, Michael Decker, the vice president for research and policy analysis at the Bond Market Association, said this mentality is changing, and that many dealers have even started to finance the development of Web exchanges.
TradeWeb, Brokertech, MarketAccess, Bondbook, and MarketSite are among the online exchanges that have received investments from dealers, Mr. Decker said. Dealers see a lot of promise in electronic trading.
This change in attitude is partly tied to increased institutional demand for online trading.
This week Greenwich will release the results of a survey it conducted with more than 1,000 companies that buy and hold fixed-income products in their portfolios. Forty percent of the companies surveyed said they invested online, versus 35% last year, and 38% of the institutions said they rated a dealers online capabilities as either very important or somewhat important to their relationship.
The percentage of mortgage-backed securities that were traded online in the first half of this year more than doubled from a year earlier, to 26%, according to the survey.
Several industry observers said that dealers are also starting to look favorably upon online exchanges as a way to deal with their steadily increasing risk management needs, a carryover from the debt crisis of 1998, which has made them much less willing to risk capital in the secondary markets.
Most dealers are preferring to make their fees through new issues rather than secondary market trading, Mr. Robertson said.
Many investors expect the broker-dealers that sold them their new issues to buy them back once the institutions decide to offload them, he said.
Roughly $69 billion of mortgage securities backed by government agencies are traded every day, according to the Bond Market Association. This includes $20 billion to $25 billion of TBAs, according to some experts.
TradeWeb estimates that nearly $3 billion of those TBAs are traded on its platform, which lets institutions send out bond inquiries to dealers and offers mutual disclosure to both parties in a transaction.
Executives with the company say this allows dealers and investors to conduct their business the same way they would by phone. The reality is that dealers are still the main liquidity providers for secondary trading in the TBA-MBS market, as they are in most other liquid fixed-income markets, Mr. Toffey said.
Jim Waters, a vice president for mortgage-backed securities trading at Keefe, Bruyette & Woods Inc., predicted that Wall Street firms will increasingly turn to online exchanges.
TradeWeb is currently used by a growing client base, he said. When it comes to the TBA business, as you have customers add on to the liquidity as well as just add further legitimacy to that type of product, it will take a while to get critical mass. But as bid-ask spreads get smaller and smaller, that is probably the route both the Street and customers are going to want to go.
