Fannie Mae last week revealed that its mortgage portfolio declined by a 14.6% annualized rate, which follows a 10% annualized drop in January.

"We believe this reflects a pickup in prepayment speeds as the 10-year yield dipped earlier in the month, which accelerated liquidation from refis," said a UBS investment research report. The continued richness of mortgages versus Fannie debt - which hindered the GSE from buying new mortgages - is another factor in the decline.

UBS noted, however, that the current low level of purchases and the portfolio contraction - which was more than analysts estimated - also shows that Fannie is disciplined in its portfolio growth.

"Consequently, we believe the risk to earnings from the portfolio shrinkage is limited at this point," wrote analysts at UBS, adding that they expect less shrinkage going forward.

Fannie's book of business - reflecting growth in the GSE's outstanding MBS issuances - increased at an annualized rate of 3.8% in January. Fannie currently predicts that total single-family originations for this year will reach approximately $1.9 trillion, while residential mortgage debt outstanding will rise at an annualized rate of 9.4%.

The GSE's outstanding MBS reached $1.32 trillion, increasing by $19 billion (a 18.5% annualized rate) from December. This reflects lower third-party acquisitions (which amounted to $45 billion) as well as higher liquidations (totaling $28 billion), according to a report by Prudential Equity Group, LLC. Mortgage-backeds liquidated at an annual rate of 25%, increasing 79 basis points from December. Prudential also noted that investor appetite for MBS rose as a percentage of business volume. Buysiders bought 84% of January's volume, increasing from 81% in December.

Sandler O'Neill & Partners, meanwhile, mentioned that the carry trade is still "alive and well" due to the continuing low short-term market interest rates and steep yield curve.

Mike McMahon, managing director at Sandler, stated that Fannie will probably not bid aggressively for mortgages just to support its growth. He said that bidding aggressively for mortgages that offer low returns is not one of Fannie's strategies. "Fannie Mae is certainly willing to wait until mortgage prices improve and allow its outstanding MBS to increase," wrote McMahon. He added that guarantee fees that were earned on mortgage-backeds owned by investors give the GSE a high return and a capital-efficient business.

Fannie's interest rate risk measures are still stable and conservative, said analysts. Its duration gap stayed at negative one month, remaining flat from December and staying within the target range of plus or minus six months.

Prudential recalled that in Fannie's second quarter conference call held in July last year, management talked about a more conservative interest rate risk management strategy. Fannie's goal is to offset between 50% to 60% mortgage optionality in its portfolio using option-based debt and conduct rebalancing actions for a tighter duration gap. Analysts also noted that the GSE hopes more frequent portfolio rebalancing will make the duration gap stay within a plus or minus six months range.

Analysts were, on a whole, satisfied with Fannie's report card. "Overall, the monthly numbers came in about as expected, with the only exception being the larger decline in Fannie Mae's mortgage portfolio," said Sandler's McMahon. He explained that January business volumes numbers are usually weak because of seasonal factors, adding that he expects the volume to increase going forward. Fannie is known to use periods of weak portfolio growth to buy back shares, said McMahon, saying that he predicts portfolio growth will spike once short-term interest rates start moving up. This would make the carry trade significantly less attractive.

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