Assignment of Trade (AOT)

What Is Assignment of Trade (AOT)?

Assignment of trade (AOT) is a transaction used primarily in the mortgage-backed securities (MBSs) to be announced (TBA) market, where the obligation to fulfill an existing forward trade is assigned by one of the counterparties to a third party.

AOTs are frequently used to avoid having to make delivery of securities into, or receive delivery of securities from, a TBA trade — a contract to purchase or sell an MBS, a bond that is secured by mortgage loans, on a specific date.

How Assignment of Trade (AOT) Works

AOT is basically a three-party agreement between an assignor (usually the originator of the underlying mortgages), an assignee (the investor), and a dealer or broker. The assignor is eager to move the mortgages off the books to remove the threat of factors such as interest rate risk, prepayment risk, and default risk. 

The assignor wants this risk gone sooner rather than later, so a hedge is sold in the form of an MBS on the TBA market. However, the MBS still has to be delivered and the AOT can be the most cost-effective way of making that happen.

Mortgage originators use AOT to facilitate the pricing and purchase of whole loans by the third party to which the TBA trade is assigned, with the agreement that the third party will then make delivery of an MBS into the original TBA trade, which was taken out by the mortgage originator as a hedge.

In other words, an AOT allows a mortgage originator to unwind its hedge position by assigning it to the third party and simultaneously agreeing to sell an equal amount of loans to that third party. The price at which the whole loans are sold to the third party is established by the price of the trade being assigned.

Example of Assignment of Trade (AOT)

The assignor sells an MBS to the dealer for future delivery, creating a hedge against some of the risks that come with the loans it has issued. At this point, the dealer is waiting for the pooled security, and the assignor is obligated to deliver it. 

Enter the third-party assignee who is willing to take on the loans immediately, collecting the income streams from them, and then delivering the MBS to the dealer and fulfilling the responsibilities of the assignor. The assignee now holds the loans, and the dealer has the MBS that the underlying loans feed into.

The assignee faces default risks but can still benefit from interest rate shifts that increase the profits from variable loans. The dealer holds the MBS and the prepayment risks that come with them as well as the agreed-upon streams of interest and principal. Meanwhile, the assignor, as the loan originator, has new space on the books to issue new loans.

This approach can reduce some of the expenses that might otherwise come in the form of fees, buybacks, and transfers.

Criticism of Assignment of Trade (AOT)

Though assignment of trade (AOT) comes with many benefits, it is not always straightforward to execute properly. Critics point out that transactions commonly consist of inputting lots of crucial information from different sources into stacks of paperwork, a labor-intensive process sometimes prone to error, and sending emails that are not always guaranteed to reach all participants.

Some industry figures have been calling for a more standardized process to be introduced, such as a single electronic platform for trade assignments, in order to make it easier for information to be tracked, logged, and archived.