With Senate Banking Committee Chairman Richard Shelby (R., Ala.)'s GSE Bill currently on the back burner, the pace of Fannie Mae's portfolio contraction expected to slow in coming months and the anticipated removal of the 30% Freddie Mac capital surplus requirement, Street analysts have become more positive about MBS demand.
"While these developments do not imply that the GSEs are going to become significant buyers of agency MBS at current levels, it should reduce the additional supply coming to market from GSE selling recently," said Bear Stearns analysts in their most recent edition of Across the Curve in Rates and Structured Products.
Alec Crawford, managing director in passthrough trading at RBS Greenwich Capital Markets, noted the expected October elimination of the 30% Freddie Mac capital surplus requirement imposed by the Office of Federal Housing Enterprise Oversight. Crawford said that while it is unlikely that Freddie Mac would spend its additional capital all at once, he expects increased interest over time in mortgage assets, specifically Freddie Mac Golds over FNMAs 30-years.
In its report, Bear cited the July monthly volume summary from the GSEs showing a pattern of shrinking retained portfolios. For instance, Freddie Mac's overall portfolio declined by $5 billion and its agency MBS holdings dropped by almost $9 billion. Fannie Mae's portfolio also showed a reduction of almost $20 billion believed to be in agency MBS. Bear reported that for 2005, Fannie's retained portfolio has contracted by $116 billion in seven months, which is equivalent to roughly $17 billion of additional monthly net supply to the agency MBS market. Aside from this, Freddie Mac has seen its agency MBS portfolio dip by $34 billion, which is equivalent to another $5 billion of monthly supply.
Going forward, Bear analysts think that Fannie Mae has already met its excess capital requirements and is unlikely to continue contracting its portfolio at the current pace. If Fannie Mae's agency MBS portfolio shrinks at the same rate as Freddie Mac's, which is $5 billion per month, this will lessen the net MBS supply that the market has to absorb by $12 billion every month. This is positive for the MBS market, offsetting any increase in fixed rate supply occurring due to declining ARM originations, said Bear analysts.
Another effect of shrinking GSE portfolios has been an expanding agency MBS investor base. In the past, domestic commercial banks and the GSEs absorbed most agency MBS. For example, through the first six months of 2003, outstanding agency MBS rose by roughly $155 billion - with above 77% finding its way into bank and GSE portfolios -leaving only $35 billion for other accounts to absorb. By contrast, through the first six months of 2005 outstanding agency MBS rose by merely $21 billion, but bank and GSE holdings dropped by $105 billion, leaving about $126 billion in net supply for other market participants to absorb. While foreign investors have played a huge role in absorbing the supply, domestic demand from money managers, insurance companies and REITs has also helped, said Bear analysts. The expanding investor base has made it possible for over $126 billion to be absorbed without any dramatic OAS widening.
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