Credit Suisse observed a surge in recent Gold 5 issuance in a recently released report.
Though current negative Gold/FNMA swaps do not justify the surge, special programs in support of Golds may explain why this is happening.
Analysts said issuance of agency 5% fixed-rate MBS is high considering the current level of mortgage rates. The recent low in 30-year fixed mortgage rates was 5.71% in early September 2005. This is particularly surprising with a weak Gold/FNMA swap valuation. Analysts believe it can be explained by special agreements between large sellers and Freddie Mac. Higher gross weighted average coupons on 5s and 5.5s issued by large sellers, both in Gold and FNMA, would imply the retention of excess servicing at current high valuations on IOs. This would suggest a favorable view of IO valuations. Some of the servicers might also monetize this value through excess servicing deals.
Credit Suisse analysts noted that the issuance of agency 30-year 5s is still high despite an increase in primary mortgage rates in the last six months. The Gold 5 issuance share of all 5s has increased despite a negative and weakening Gold/FN swap. The percentage has increased to 55% through January 2006, up from 48% in September 2005. Gold 5s issuance of $34.9 billion from the third quarter of last year through January is comparable to $31.8 billion in FNMAs, despite a 2 1/8 tick weakening in the Gold/FN 5s swap to 2.75 ticks over this period. This swap has weakened further to more than negative-three ticks on the back of strong Mega 5 issuance, driving the dollar roll on FNMA 5s higher.
The large seller share of Gold 5s issuance is higher compared to other issuers. Credit Suisse analysts believe the strong issuance in Gold 5s is probably resulting from special agreements between these sellers and Freddie. Examining this share for the large sellers reveals that the high issuance share on Gold 5s is particularly notable for Countrywide, Wells Fargo and Washington Mutual.
Thirty-year 5s and 5.5s issued by large sellers - both in Golds and FNMA - have higher gross weighted average coupons, which implies excess servicing retention by these servicers at relatively high IO valuations relative to coupon swaps.
Analysts know that the relative richness of 30-year 5s pass-throughs versus higher coupons contributes to 5s IOs looking rich versus the 5.5/5 swap. This is consistent with the incentive for sellers to continue to issue into these rich valuations on the 5% coupon. Higher gross weighted average coupons in 5.5% coupon issuance by large sellers suggests a favorable view of valuations on IOs.
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