MBS volume was average into midweek with hearings in Washington, the announcement of a new financial aid plan, a Senate Stimulus Bill vote and the American Securitization Forum conference held in Las Vegas providing distractions.
Mortgages rallied on Monday as Treasurys sold off modestly in front of the $67 billion quarterly refunding, while equities held in a holding pattern as participants waited for Treasury Secretary Timothy Geithner's plan and a Senate vote on the Stimulus Bill. The day saw buying from money managers, overseas investors and the Federal Reserve, while supply was limited to just $1 billion. Some real and fast money profit taking showed up later in the session on the strong gains, but spreads still closed eight ticks tighter to the curve and swaps on 4s through 5s, while higher coupons tightened less.
Tuesday opened with a sharp flight-to-quality rally that only strengthened on the lack of details included in Geithner's Financial Stability Plan. The Dow ended the day down nearly 400 points, while the 10-year Treasury gained 50/32nds.With Treasury prices moving higher, profit taking emerged from money managers and hedge funds, while supply picked up to more than $2 billion. MBS ended the day modestly weaker. Treasurys continued to gain on Wednesday, which pressured MBS with better selling and higher originator supply.
Month-to-date through Feb.10, excess return over Treasurys on Barclays Capital's MBS Index was 33 basis points, and compared favorably with ABS (negative 98 basis points), CMBS (negative 54 basis points) and Corporates (23 basis points).
Geithner Fails, Senate Passes
Geithner's plan failed to provide an actual approach to help the housing market or the toxic assets held by financial institutions, now termed "legacy loans and assets." "We will announce the details of this plan in the next few weeks," the Treasury secretary said. Meanwhile, a public-private investment fund would be created to buy toxic assets by providing government capital and financing as well as leveraging private capital to help get the private markets working again. He said this fund targets the "legacy loans and assets" that are adversely impacting financial institutions. At the moment, however, the Treasury is still examining different structures for the program and getting input from market participants. He added that the administration believes this program "should ultimately provide up to one trillion in financing capacity," starting with $500 billion.
Other aspects of the plan included a comprehensive stress test for banks to determine their health and viability for receiving additional government aid and working with the Fed to expand the Term ABS Loan Facility (TALF). Despite the lack of a plan to address the housing crisis and the toxic assets on bank balance sheets, Geithner said, "Our plan will help restart the flow of credit, clean up and strengthen our banks and provide critical aid for homeowners and for small businesses."
Deutsche Bank Securities economists warned that if the government does not take the toxic assets off bank balance sheets, the financial system will remain broken, leading to economic underperformance, higher unemployment and greater deterioration in the tax base.
Mortgage Application Activity Tumbles
As expected, mortgage application activity fell in the week ending Feb. 6 in response to higher mortgage rates. The Mortgage Bankers Association reported that the Refinance Index tumbled 30.3% to 2722.7 - its lowest level since November of 2008's 1200 area, when mortgage rates were over 6%. The Purchase Index also declined - 9.8% to 235.9. Despite attractive mortgage rate levels, the government has indicated that it wants to push rates toward 4.5%, and many borrowers are likely waiting for rates to decline below 5%.
As a percentage of total applications, refinancing share declined to 66.7% from 73.2% in the previous week. ARM share increased slightly to 2.5% from 2.1%.
Mortgage/Prepay Outlook
MBS analysts continued to favor mortgages with a preference for up-in-coupon. JPMorgan Securities analysts, for example, said to stay overweight mortgages versus Treasurys because of the increasing Treasury supply, wider spreads versus agency debt and expectations for narrower swap spreads. They added that the latest prepayment report that demonstrated the credit impairment in higher coupons supported the up-in-coupon trade. They particularly like 6.5s.
Deutsche Bank analysts, however, preferred 6% coupons versus 6.5s and 7s on concerns of default prepayment risk. They acknowledge that while 6.5s and 7s haven't yet shown default prepayments, the increased focus on loan modification and foreclosure preventions makes them cautious.
Barclays Capital and Bank of America Securities analysts remained overweight on the mortgage basis as well, primarily because of government buying. Barclays said that the near-term outlook for reduced supply as a result of higher mortgage rates is a positive technical.
Fed purchases through Feb. 4 reached $91.7 billion in agency MBS, or $4.2 billion per day. Meanwhile, the Treasury has bought a total of $94.2 billion GSE MBS from September through January, or about $1.1 billion per day.
The initial outlook on prepayments in February suggests a more moderate increase than previously expected - about 10% for both FNMAs and GNMAs versus a 50% increase from January. Paydowns are estimated at the mid-$80 billion range. The largest percentage increases based on vintage and coupons, respectively, are expected for 2008s and in 5s and 5.5s, which reflects the ongoing credit impairment, tight underwriting conditions and lender capacity constraints in the market currently.
Other factors influencing speeds are one less collection day in February, while the Refinance Index averaged 3% lower in January compared with December despite more attractive average mortgage rate levels.
March and April prepayment speeds at this time are seen slowing modestly on conventionals while continuing to increase on GNMAs.
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