This article is co-authored by Dean Rohne and Stephen LaBarbera.

Dollar roll transactions have evolved into a strategic balance sheet and earnings management tool in today’s high-rate, capital-constrained economy. Many dollar rolls are currently “in the money,” meaning front-month, to-be-announced (TBA) mortgage-backed securities (MBS) prices exceed those of future settlement months, generating positive drop income. 

For credit unions and banks, this is not just a trading phenomenon. It reflects: 

• Structural demand for near-term MBS exposure.
• The economics of cheap, flexible financing.
• Accounting treatment to allow organizations to retain asset exposure while effectively adding low- or even negative-cost borrowing. 

The Dollar Roll Marketplace Background 

A dollar roll is the sale of an MBS for current-month settlement paired with an agreement to repurchase a substantially similar security in a future month. Transactions are executed using TBA securities, which specify issuer, coupon and maturity—but not exact pools. 

Dollar rolls provide dealers with a convenient way to obtain promised MBS to meet delivery obligations. These transactions offer the following benefits: 

• Avoid the operational and reputational cost of failing delivery.
• Provide short-term financing at competitive rates.
• Offer flexibility compared to a repurchase agreement or outright asset sales. 

Market demand ultimately determines the economics of these transactions and the implied cost of funds. 

Drop Income: How Demand Translates into Profitability 

When demand for front-month TBAs exceeds supply, the price of the current-month contract rises relative to the forward contract. This price difference is known as the drop. 

• Positive drop: Front-month price > back-month price
• Negative drop: Back-month price > front-month price 

A positive drop generates income for the seller and typically reflects tight near-term supply, strong delivery demand and favorable financing conditions. 

Why Front-Month TBAs Are in the Money Today 

Structural Demand to Meet Near-Term Obligations 

Dealers must deliver MBS into existing commitments. In today’s environment: 

• Specified collateral can be scarce.
• Balance-sheet capacity is limited.
• Failing delivery is costly. 

Dollar rolls allow dealers to source near-term exposure efficiently, concentrating demand in the front month and lifting its price. 

Balance-Sheet Constraints and Capital Efficiency 

Higher interest rates and regulatory constraints have made balance sheet usage more expensive because: 

• Holding cash MBS consumes capital and leverage.
• Repurchase agreement funding adds both balance-sheet usage and earnings volatility. 

Dollar rolls allow firms to maintain economic exposure to MBS without permanently expanding the balance sheet. 

Favorable Implied Financing Economics 

The implied financing rate embedded in dollar rolls is frequently below alternative funding costs. When roll-implied financing is cheaper than repurchase agreements, relative-value participants arbitrage the difference, reinforcing front-month richness and sustaining positive drop income. 

Understanding a Dollar Roll: Transaction from Beginning to End 

To help gain an understanding of dollar rolls, below is an example reflecting all stages of the transaction. 

The financial institution starts with MBS with the following characteristics: 

For accounting purposes, qualifying transactions are treated as secured financing; the MBS remains on balance sheet as available-for-sale (AFS) with fair value changes recorded in other comprehensive income (OCI), while drop income is recognized as interest expense (or income) on financing.  

Below is actual dollar activity, more specifically selling an MBS security (or rolling due commitment) and buying an MBS forward purchase commitment or in the end buying back substantially similar MBS security. 

When drop income is greater than forgone interest income, it results in a negative implied financing rate. 

It is important to note, to complete this transaction, the cash from financing is invested into an interest-bearing deposit or other short-term investment. In this example, if the interest earned was 3.50%, the increase to net income would have been approximately $62,000. 

Phantom Securities and Borrowing Economics 

Retaining Asset Exposure Without a Sale 

From an accounting standpoint, dollar rolls often function as financing transactions rather than true asset sales. Under applicable accounting guidance, firms may be required to recognize “phantom” MBS securities on the balance sheet. 

These phantom securities ensure your financial institution: 

• Maintains AFS classification.
• Continues to be carried at fair value.
• Records unrealized gains and losses through OCI. 

Economically, it is as if the securities were never sold. 

Borrowing Treatment and Income Statement Impact 

The net activity associated with the dollar roll, including the drop, is recorded as interest expense on borrowings, consistent with accounting guidance. As a result: 

• The firm retains MBS exposure.
• Adds a borrowing to the balance sheet.
• And finances that borrowing at a rate implied by the roll. 

When the roll is “in the money,” this borrowing may carry a very low or even negative effective interest rate, enhancing earnings without asset growth. 

Why This Matters for CFOs 

This accounting treatment has important implications, including: 

• OCI volatility remains linked to MBS price movements.
• Net interest income reflects the economics of roll financing.
• Leverage and liquidity metrics can improve relative to repo-funded ownership. 

The result is a structure that preserves asset exposure while optimizing capital efficiency and funding costs. 

Here to Help 

Dollar roll financing transactions remain a powerful and flexible tool for credit unions and banks that trade or hold agency MBS. By providing cost-effective financing, balance sheet optimization and strategic portfolio flexibility, dollar rolls offer advantages not found in traditional funding structures. However, your institution must carefully evaluate the associated market, operational and regulatory risks to ensure dollar rolls contribute positively to your broader risk return objectives. 

Whether you’re exploring dollar roll financing or need help navigating the journal entries for these complex transactions, Doeren Mayhew’s credit union and bank pros stand ready to assist.