Fannie Mae (FNMA) and Freddie Mac (FHLMC) are Government-Sponsored Enterprises (GSEs) chartered by Congress. Their mission is to Provide liquidity, stability, and affordability in the U.S. mortgage market. They achieve this by converting individual home loans into tradable securities (MBS). FNMA and FHLMC convert individual home loans into standardized, guaranteed securities—keeping mortgage lending active and the MBS market liquid. They Buy mortgage loans from lenders, Pool similar loans together, Issue Mortgage-Backed Securities (MBS) and Guarantee payments to investors. Even if borrowers default, investors continue receiving payments. Fannie Mae (FNMA) Freddie Mac (FHLMC) Works more with large national banks Works more with smaller banks and lenders Broad institutional reach Strong regional lender focus What Happens Why It Matters Buy mortgages from banks & lenders Frees up lender capital to issue more loans Package mortgages into MBS Converts illiquid loans into tradable securities Issue TBA-eligible securities Enables standardized trading in secondary market Guarantee payments to investors Reduces credit risk and increases investor confidence

Let us now explore the MBS and TBS with examples to gain more clarity on this very important topic. Example: Item Value Agency Fannie Mae Product 30-Year Fixed Rate Mortgage Security Coupon 5.0% Settlement Month March Trade Size $10,000,000 Trade Price 99-16 Decimal Price 99.50 Settlement Amount $9,950,000 Full Lifecycle Table Stage Operational Event Responsible Party System / Infrastructure Example Security / Data Notional Amount Detailed Operational Explanation Mortgage Origination Individual home loans are issued to borrowers Mortgage lenders / banks Loan origination systems Mortgage 1 = $350,000Mortgage 2 = $420,000Mortgage 3 = $290,000 Total loans $500M across thousands of borrowers "Mortgage lenders originate home loans to borrowers purchasing residential property. Each loan has its own interest rate, maturity, and repayment schedule. "; Loan Aggregation Similar mortgages are grouped together Mortgage originator Mortgage aggregation systems 30-year fixed loans between 5.75% and 6.25% $2.5B aggregated loans "Thousands of similar mortgages are grouped together based on characteristics such as loan type, maturity, credit standards, and agency eligibility requirements. "; Pool Creation Mortgage loans form a mortgage pool Agency securitization program Fannie Mae securitization platform Pool ID FN100111Coupon 5.0% $50,000,000 pool "Mortgage loans are packaged into pools which will generate monthly cash flows from borrowers. Each pool receives a unique pool number. " Security Issuance Mortgage pool becomes an agency MBS Fannie Mae Agency security issuance systems FN100111 30-yr 5.0% $50,000,000 "The pool is securitized into a mortgage-backed security. Investors who buy the security receive interest and principal from underlying borrower payments. "; Market Trading Generic TBA contract traded Broker-dealer and institutional investor Trading platforms FNMA 30yr 5.0% March TBA $10,000,000 "Participants trade exposure to a standardized mortgage product without specifying exact pool numbers yet. "; Trade Execution Buyer and seller agree on TBA trade Bank A and Dealer B Trading system / OMS Buyer = Bank A Seller = Dealer B $10,000,000 "Trade terms are agreed including agency, coupon, product type, price, and settlement month. "; Trade Capture Trade recorded internally Broker-dealer operations Order management system Trade ID 783452 $10,000,000 "Trade details are stored in internal trading systems before submission to clearing infrastructure. "; Trade Submission Trade submitted for clearing Dealer B FICC trade submission interface FNMA TBA 5.0% $10,000,000 "Both buyer and seller submit trade details to the Fixed Income Clearing Corporation for comparison. "; Trade Comparison Trade sides are matched FICC MBSD Matching engine Buyer Bank A Seller Dealer B $10,000,000 "FICC verifies that both trade submissions match on product, coupon, price, and amount. "; Clearing Guarantee FICC becomes central counterparty FICC MBSD Clearing infrastructure Trade accepted $10,000,000 "FICC effectively stands between buyer and seller, reducing counterparty risk in the settlement process. "; Netting Calculation Offset trades between firms are netted FICC Netting engine Dealer sells $70MDealer buys $50M Gross = $120M Without netting, all trades would settle individually. Netting compresses obligations. Net Obligation Final settlement obligation created FICC Settlement system Net deliver $20M $20,000,000 Dealer B must deliver $20M of FNMA 30yr 5.0% securities to Bank A. Settlement Calendar Assignment Trade assigned to settlement cycle SIFMA settlement calendar Industry calendar Class A settlement group $20,000,000 net Class A corresponds to standard 30-year Fannie Mae and Freddie Mac MBS. Pool Selection Seller selects mortgage pools Dealer B operations Pool management system FN100111FN100112FN100113 $10,000,000 allocation Seller identifies eligible pools matching agency, coupon, and product characteristics. Pool Allocation Pools assigned to specific TBA trade Dealer B Allocation systems FN100111 = $4MFN100112 = $3.5MFN100113 = $2.5M $10,000,000 Pools must satisfy good delivery rules including minimum pool size and correct product type. Pool Notification Seller notifies buyer of pools Dealer B EPN / MBSE messaging Pools FN100111 etc $10,000,000 Notification is sent electronically on the designated Notification Date in the settlement calendar. Pool Validation Buyer checks pool eligibility Bank A operations Risk and settlement systems Verify coupon and agency $10,000,000 Buyer confirms pools meet TBA delivery requirements. Settlement Preparation Cash amount calculated Buyer operations Treasury / funding system Price 99-16 = 99.5 $9,950,000 Cash payment obligation is calculated using trade price multiplied by par value. Securities Delivery Mortgage pools transferred Seller via settlement agent Fedwire Securities Service FN100111FN100112FN100113 $10,000,000 Seller delivers securities electronically through the book-entry securities transfer system. Cash Transfer Cash payment made Buyer via clearing bank Settlement bank infrastructure Payment $9,950,000 $9,950,000 Cash is transferred simultaneously with securities delivery. DVP Settlement Securities and cash exchanged simultaneously Settlement infrastructure Fedwire + clearing bank Delivery versus payment $9,950,000 DVP ensures that securities move only if cash is received at the same time. Settlement Completion Trade lifecycle completed FICC confirmation Clearing system Settlement confirmed $10,000,000 par The transaction is marked settled and positions are updated in participant accounts. ✦ ✦ ✦ Investor Economics (Starting Point) Item Value You Paid $9,950,000 You Own $10,000,000 (Par) Coupon 5.0% Income Monthly interest + principal Return Driver Coupon + prepayments Step 1 — Interest Income Interest is earned on par (not price) Annual Interest: = 5% × $10,000,000 = $500,000 Monthly Interest: = $500,000 ÷ 12 = ~$41,667 Step 2 — Principal Return (Amortization) Principal is returned every month, You do NOT wait until maturity 👉 Example (Month 1): Component Amount Interest $41,667 Principal (scheduled) $25,000 Total Cash Received $66,667 Step 3 — Prepayment Impact Borrowers may repay early → you receive more principal Example with prepayment: Component Amount Interest $41,667 Scheduled Principal $25,000 Prepayment $15,000 Total Cash Flow $81,667 Step 4 — Premium Effect (Critical Insight) You paid $9.95M for $10M par and that means, you bought at a discount (below par), As principal returns, you receive full par value Item Value Purchase Price $9,950,000 Par Received Over Time $10,000,000 Gain from Price $50,000 This gain is realized gradually as principal is repaid Step 5 — Monthly Economic View Component Amount Interest Income ~$41,667 Principal Return ~$40,000 (incl. prepay) Price Benefit Built into principal return Total Cash Flow ~$80,000/month Step 6 — What Drives Your Return Driver Impact Coupon (5%) Determines base income Price (99.50) Creates discount gain Prepayments Changes timing of cash flows Interest Rates Drive borrower behaviour I.e. if you invested $9.95M, you will receive monthly cash flows (~$70K–$80K), You will gradually get back $10M principal and the Timing depends on borrowers’ behaviour