In a report released last week, Countrywide Securities discussed the potential for increased originator issuance in 5s. Analysts noted that in April, 30-year 5% coupon production surged, and was "noteworthy in its absolute size and the large proportion of 30-year conventional production it comprised," said analysts. The jump in 5s was due to conditions in the secondary market and specifically the Fannie 5.5/5.0 swap, which has done poorly over the past month, according to Countrywide analysts.
Countrywide theorized that the coupon swaps level has a direct relationship on issuance economics and which coupons offer the optimal execution for originators. As an example, analysts point out that if the Fannie 5.5/5.0 swap is trading at relatively wide levels, this suggests the higher coupon is trading well and so originators profit more by selling the higher coupon product, and vice versa when the swap is trading poorly. This calculation is meaningful for loans with rates that can be securitized into either coupon. In Countrywide's analysis, it seems that when execution is comparable between 5.5s and 5s, many originators will elect to issue the higher coupon and retain less servicing, but if the differential becomes great enough - like in April - lenders will issue the lower coupon and retain more servicing.
Countrywide also points out that the level of rates also contributed to the production shift, noting only loans with a note rate of 5.75% or higher can be securitized into Fannie 5s or 5.5s. Lending rates in March were between 5.75% and 6%. Countrywide says more than half of the loans it pooled with 5% coupons in April had note rates that were 5.75% or higher. Because of the execution issues in 5.5s versus 5s, the originators are issuing the lower coupon, which subsequently has a higher than normal weighted average coupon.
Countrywide highlights some "interesting" implications regarding all this. One is the FNMA 5 roll that has been trading special on the perception that supply will be limited. Countrywide says, however, that even if rates back up to the 5.75% area, supply of 5s could stay heavy if swaps do not recover from their current levels, eventually applying pressure to the rolls. Another point is that the higher WAC for Fannie and Gold 5s issued in late 2004 and early 2005 should be desirable in markets where the bonds are trading at a discount because of the potentially faster speeds.
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