Last Thursday Fannie Mae announced that its gross mortgage portfolio shrank for the fifth consecutive month to its lowest level since July 2003. The GSE's investment portfolio fell by a 13.6% annualized rate in March, after dropping 19.1% in February, according to Fannie's monthly volume summary. This is not surprising as the GSE still has to comply with the September deadline to reach the capital requirement set by the Office of Federal Housing Enterprise Oversight.

The GSE's commitment to buy mortgages jumped to $10.59 billion in March, the most since November from only $3.1 billion in February. Analysts said this could be seen as a sign of future portfolio growth. However, commitments could not catch up with liquidations - rising to $17 billion in March from $15.55 billion in February - as well as $4.8 billion in outright sales, even though March sales fell from $9.54 billion in February. The quarter's sales have reached $20.7 billion, which has exceeded the $16.45 billion mortgage bonds sold during the whole of 2004.

Meanwhile, Fannie Mae's mortgage portfolio duration gap, which is a measure of interest rate risk exposure, rose to one month in March versus zero months in February.

Analysts from Merrill Lynch, which released a report before Fannie's volume summary was released on Thursday, said that they would not be surprised to see net positive portfolio purchases though still negative growth, which could be considered positive for the MBS sector. Bear Stearns analysts said that although finding buyers for the MBS that Fannie previously purchased is challenging, despite recent rate volatility, there are "signs of promise." They cited positives such as the improved risk-adjusted carry in MBS, slight fixed-rate supply, and Asian interest.

Meanwhile, a lot of Fannie Mae's future activity hinges on the current Congressional hearings being held on the new GSE regulator. Expectations are for the House Financial Services Committee to mark-up Congressman Richard Baker (R-La.) bill in the next month or so, with the possibility that the Committee may vote on the GSE Regulatory Reform prior to Memorial Day.

However, Merrill Lynch added that, "the bottleneck to enacting legislation is the Senate." It is uncertain whether lawmakers can come up with a compromise on the GSE portfolio cap issue. Analysts noted that last year the Bush administration did not budge on its stance regarding receivership, which caused a stall in the legislation.

The administration currently insists on significant reductions in the agencies' portfolio size. Merrill believes that the chances of this being written into law is very slight, adding that deliberations on the future size of the GSEs over the next month or so will determine if legislation could actually be enacted this year. While analysts are generally optimistic on this front, if a compromise is not reached in the next few months, it is possible that other issues such as judicial nominations, social security, and tax reform could push the GSE regulatory reform issue to the back burner, said Merrill.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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