As the GSEs continue to buy into the non-agency sector - converting "True TBA" securities into something more akin to non-agency MBS - and as the agencies' yearly loan limit increases, the prepayment risk between the jumbo non-agency market and the "True TBA" sector has converged, according to a recent report by Bear Stearns.

Bear Stearns says that this convergence trend, which is reflected in 2001 prepayment data, is expected to continue going forward. Investors should therefore "lock in" the additional spread advantage offered by non-agency product while it is still available.

"The premise of the report is that because adverse loan selection has made the agency TBA market more negatively convex, we have observed a convergence trend between traditional jumbo non-agency prepayments and the agency pass-through market," said Dale Westhoff, senior managing director and head of MBS Research at Bear Stearns.

Factors affecting the TBA market

Fannie Mae and Freddie Mac have, in recent times, increased their exposure to non-agency collateral: low loan balances, Alt-A securities, etc. According to the Bear Stearns report, so far this year the bank estimates that about 60% of Alt-A production has gone the way of the agencies.

Because "True TBA" pools have become more heterogeneous, Bear said that TBA deliverable securities are now more prone to being prepayment-sensitive than the universe as a whole. Furthermore, the agencies' yearly loan limit increase - now up to $275,000 - has a greater net impact on agency prepayments compared to non-agency prepayments.

The increased prepayment sensitivity of these "True TBA" pools is further enhanced by increased refinancing efficiency made possible by Internet access.

Because of these factors, the observed refinancing characteristics for agency and non-agency MBS have moved closer together. In fact, according to the report, in some cases, true TBA agency pools have exhibited faster prepayment speeds than comparable jumbos.

The increasing similarity between the prepayment behavior of jumbo non-agency collateral and "True TBA" agency securities will lessen the inherent advantage in holding non-agency paper, the report said.

Lock in while the going is still good

Therefore investors in non-agency paper should take full advantage of the price concession currently available to them while it is still there, Westhoff said.

There are other advantages to holding non-agency paper as well: Fannie and Freddie, unlike in non-agency pools, provide much less loan level information. Investors are generally not informed about the loan-to-value ratio, credit quality of the collateral and the FICO scores of the borrowers.

According to Bear Stearns "non-agency investors have the distinct advantage of having access to full loan level disclosure. This allows investors and analysts to better understand and quantify their investment risks relative to the agency sector where there is no loan level disclosure."

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