Early outlooks for 2012 suggested net organic supply at around $10 billion with an added volume of more than $78 billion coming from paydowns/sales from the GSE and U.S. Treasury portfolios.

Meanwhile, the supply will likely be adequately absorbed by banks, money managers, REITs and the Federal Reserve - this includes paydowns only and not the potential for a third round of quantitative easing by the Fed.

At this time, Barclays Capital analysts in research said: "Agency MBS appear positioned to perform well in 2012 due to a favorable supply/demand landscape and attractive valuations."

Meanwhile, Nomura Securities MBS analysts expect the lack of growth in the agency MBS outstanding balance to give a "significant positive tone to the agency MBS market in 2012."


Bank demand for the next year is currently estimated at $55 billion net.

Morgan Stanley analysts expect that banks will be the single most important source of demand for loans and securities as a result of the weak economy and low-yielding environment with the Fed keeping its accommodative stance on monetary policy in place.

Additionally, the regulatory environment for higher capital and liquidity ratios under Basel III also favor MBS, especially GNMAs, the analysts added.

Meanwhile, Barclays believes that most of the bank demand will come from mid-size and smaller banks as larger banks will be constrained by the unfavorable regulatory landscape.

Overseas investor demand should be essentially flat from this year, with buyer interest remaining focused on GNMAs.

The support from REITs is projected at $20 billion. Barclays analysts noted that REITs are not likely to be the source of demand they were in 2011 because of Securities and Exchange Commission (SEC) regulatory requirements and macro uncertainty resulting from the European crisis.

Should the SEC maintain the REITs' exemption under the Investment Company Act of 1940 - giving these companies more leeway to invest in MBS - they can once again become more active MBS buyers.

UBS mortgage strategists expect the SEC to allow REITs to keep their current investment exemption in the beginning of 2012.

They also expect that funding issues in the market related to the European Union (EU) crisis will clear up.

These two factors will allow REITs to become active again in raising capital. While the strategists do not expect the investment activity to be at this year's high pace, they said it should still be greater than pre-2011 levels.

By the end of 2012, the GSEs retained portfolios are required to drop to $656 billion. As of the end of October, Freddie Mac's portfolio stood at $669.1 billion, while through September Fannie Mae was at $722.2 billion.

Morgan Stanley analysts estimated that for 2012, the combined GSE portfolios will need to decline by $60 billion with run-offs projected at $40 billion.

The money manager outlook is mixed. Barclays analysts anticipate that they will ramp up their holdings in 2012 because of attractive valuations and better yield compared to other asset classes in the index.

Meanwhile, Morgan Stanley analysts said that money managers can increase their holdings in anticipation of the third round of quantitative easing. They believe there is a strong possibility of this happening and projected $250 to $300 billion in 2H12.

However, without this event, MBS holdings were expected to experience only a modest increase since corporate spreads are more attractive. They warned that if the third round of quantitative easing was large, money managers can become net MBS sellers given that they were under the first round of easing. Current projections put money manager demand at more than $30 billion.


Heading into 2011, the consensus was for muted prepayment risk because of the continued tightening in credit standards, ongoing weak home valuations, and capacity constraints at the mortgage bankers.

Indeed, this was the case with aggregate speeds holding below November 2010's peaks.

According to eMBS data, 2011 speeds through October averaged 17.1 CPR for FNMAs, 17.2 for FHLMC Golds, and 11.4 for GNMA Is.

This compares with between 23 and 24 CPR for the GSEs for 2010 and 16.3 for GNMA when borrowers began to take advantage of the various government programs, while the Fed was engaged in purchasing MBS to help lower mortgage rates.

Factoring into the outlook were expectations for a general rise in mortgage rates. Through the first half of the year, mortgage rates ranged between 4.5% and 5.0% with an average of 4.8%.

Meanwhile, as EU and global growth fears escalated, leading the Fed to take more actions, mortgage rates have ranged between a record low of 3.94% and 4.60% with an average of 4.22% through the second half of the year.

The Mortgage Banker's Association's Refinance Index was relatively muted for the year ranging between a high of 4867 and a low of 2821, compared to 5085 and 2037 in 2010.

Several analysts expected that the Home Affordable Refinance Program (HARP) would be extended, which it was through 2013. HARP 2.0 also looks to be the major prepayment theme for 2012.

While credit conditions remain very tight with home valuations expected to decline further, Barclays analysts said that 2012 has more prepayment risk than 2011 as a result of several factors. These include: HARP 2.0, servicer idiosyncrasies and the gradual reduction of refinance frictions including cost, hassle and accessibility to streamlined refinancing channels like HARP.

They noted that speeds, after adjusting for rates and collateral attributes, have likely bottomed, and 2012 could see the first rebound.

At the same time, Nomura analysts expect the trend for reduced refinancing activity to continue despite low rate levels. They also anticipate that burnout on seasoned issues will increase. The lack of lender competition, they said, will keep refinancings limited.

Unless lenders become more aggressive at refinancing borrowers through HARP 2.0, they think that the Refinance Index will remain weak relative to rate levels.

Overall, Barclays and Nomura analysts expect HARP 2.0 to boost one-year speeds in the range of 3 CPR to 7 CPR.

However, the full effect of HARP 2.0 is not expected until the second quarter, according to Barclays and Bank of America Merrill Lynch analysts.

Specifically, Credit Suisse analysts said they expected the full ramp up of HARP 2.0 to be delayed until May 2012 for FNMA speeds. This is because the GSE's increased automated valuation model or AVM coverage under its DU Refinance Plus program will be unavailable until March 2012.

Before that, the next three prepayment reports - November through January - are expected to be very uneventful affairs. The 30-year prepayments are projected to increase around 5% or less in November while December and January speeds are expected to be flat to slower on average across the coupon stack.

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