JPMorgan Securities weighed in on the effects on the MBS market of Standard & Poor's lowering its long-term sovereign credit rating on the U.S. to 'AA+' from 'AAA'. They expect forced MBS selling to be very small.
One of the reasons is because agency MBS are not explicitly rated by the rating agencies. This is why a U.S. downgrade does not directly affect MBS, though the issuers themselves, Fannie Mae and Freddie Mac, are likely to be downgraded.
Another reason is that bank regulators such as the Federal Reserve have said that capital requirements would not change as a result of the downgrade. Typically, capital requirements would need to fall below 'AA-' before bank capital requirements might be impacted. As a precedent, inspite of the downgrades in non-agencies over the past several years, bank non-agency holdings actually stayed stable
The conservatorship agreement of 2008 requires the U.S. Treasury to back the GSEs with
unlimited capital until 2012, and considerable backing thereafter. The language surrounding
this agreement is quite strong, according to analysts.
Thus there is no risk, according to analysts, of a disruption to agency MBS cashflows because of the downgrade. Analysts think that agency MBS investors are entitled to the underlying cashflows of the mortgages, and then become general creditors to the GSEs after any shortfall.
They think that the largest effect on mortgages to be indirect via higher vol in the very near term, which could in turn spur nominal spread widening. They cited Japan as a precedent since the country saw higher vol around downgrade events in 1998 and 2001.
The impact on repo haircuts and margins are not as clear, but if higher vol were sustained, these
funding pressures could pressure mortgages wider.
Over the crisis of 2008, higher haircuts and margins were drivers of mortgage spreads. At this point, JPMorgan analysts do not expect higher haircuts, although this is a factor they are watching for.
Analysts do not expect this news to drive GNMA/FNMA spreads. They are still negative on GNMA/FNMA swaps because of fundamental valuations.
They are also staying modestly overweight the mortgage basis. Fundamental valuations (nominal spreads and OAS) are still attractive, though short-term hedging costs have now increased. Analysts would added to their position if mortgages were to widen considerably based on the news.
They don’t expect this news to drive GNMA/FNMA spreads and are remaining negative on GNMA/FNMA swaps because of fundamental valuations.
They are still modestly overweight the mortgage basis. Fundamental valuations (nominal spreads
and OAS) are still attractive, they said, though short-term hedging costs have risen currently. Analysts said that they would add to their position if mortgages were to widen considerably as a result of this news, they said.
