Despite the recently declining agency MBS marketshare, analysts expect the sector to regain ground with expected home-price deceleration combining with a diminishing bid for credit in non-agency MBS. There is also the added effect of GSEs increasing their presence in the ARM sector, an effort bolstered by the flattening yield curve.
"In the event of a slowdown in the housing market, the bid for credit in the non-agency market is likely to abate, making agency execution more competitive," reported Bear Stearns analysts in recent research, explaining that non-traditional agency mortgage product execution has been less attractive than in the non-agency space, particularly since the GSEs have a longer-term view on credit.
To highlight the drop in agency MBS, Bear analysts note the plunging agency share of securitized product - from above 85% to 60% in 1Q05. Despite the fact that in the fixed-rate arena, liquidity and existence of the TBA sector gives GSEs an advantage, the higher ARM share and the increasing bid for credit have hurt the GSEs in recent years.
This trend, however, is about to change - particularly with rating agencies taking a harsher look at some of the non-amortizing affordability products currently proliferating. Bear Stearns analysts added that rating agencies could tip the market in favor of the agency-conforming sector - despite declining credit enhancement levels, rating agencies have increased recently, specifically in terms of the option ARM product. "In a slowing housing market environment, this recent trend is likely to continue, pushing enhancement levels higher and thereby making agency execution more attractive," Bear analysts added.
Another factor that may boost the agency originations is the recent curve flattening, added analysts. In a recent report, Merrill Lynch analysts stated that this event, coupled with stubbornly low 30-year fixed mortgage rates, could cause non-agency ARM issuance to drop from its "current lofty levels" supported by the popularity of the ARM product in the Jumbo [MBS] market and in subprime loans where issuance is concentrated in two- or three-year reset dates. Furthermore, although 15- and 30- year fixed rate [mortgages] still predominate agency MBS - holding 82% of the market, with ARMs consisting of 12.4% - this is expected to change. "We believe that the current popularity of hybrids in the agency [MBS] market will fuel the growth of ARMs in the sector in the future."
Other sell-side analysts added that another factor potentially increasing agency ARM share is the GSEs' increased willingness to charge guaranty fees on ARM IO products - which they had previously avoided - in a bid to gain hybrid market share. Despite these attempts, however, better execution is currently still found in the ARM IO private label space, especially for loans with Alt-A characteristics. But analysts are expecting the GSEs to improve pricing in a bid to gain market share in the sector.
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