With the 6% coupon trading near par, the MBS market is finally seeing substantial production in this coupon from originators. Many analysts attribute the rise not only to higher mortgage rates, but also to the fact that too much excess servicing is influencing originators to create low weighted average coupon 6s instead of high weighted average coupon 5.5s.
Amin Majidi, head of mortgage research at Deutsche Bank Securities, reports that with rates backing up, 6s have finally become a production coupon. Currently, the primary mortgage rate used in Deutsche's model is roughly 6.37%, although rates have actually reached 6.50%, making 6s the current TBA coupon. Majidi added that the higher average loan size by January - based on the changing conforming price limits expected to rise over $410,000 from $359,650 currently - should also result in a fraction of the jumbo mortgages originated in recent months to become agency TBA delivery eligible. In general, the average loan size on low WALA 30-year conventional 5.5s should be a good proxy for where new 6s are headed.
Most secondary market issuance comes in the two coupons on either side of par - currently 5.5s and 6s. As the back up in primary rates filters through to the secondary market, it should experience a pick-up in 6% coupon issuance, particularly in December and January, according to Laurent Gauthier, executive director and head of mortgage and asset-backed research at Morgan Stanley. When the conforming loan limit is raised, loans that would have been previously classified as jumbos can then be issued as agency collateral, leading to a rise in the overall loan balance. "Current jumbo rates would imply that this effect would be felt most in 6s," Gauthier said.
"This supply pressure should be a negative for 6s, but we expect that pressure to come only in December and January," noted Gauthier, adding that current TBA 6s are somewhat attractive, as they may become specified collateral and trade at a pay-up to TBAs once issuance in the coupon picks up.
JPMorgan Securities Head of Mortgage Research David Montano expects January TBA 6s will be made up mostly of longer duration purchase origination close to the conforming limit. In his mid-week commentary, Montano stated that loan sizes for new FNMA 6% pools average roughly $200,000. By either January or February, when the limit would have increased to over $300,000, 6% coupon supply may rise significantly, with more than $15 billion FNMA 6s likely settling in January, tripling the most recent production.
Montano expects that January FNMA 6 TBA will lead to about a five basis point dip in OAS on the higher option cost, resulting from the larger loan balances and declining Alt A share. Thus it would not be surprising if some dealers would take delivery of FNMA 6s for December and sell the 2005
production at a pay up in 2006. This would, in turn, result in a strong December to January roll, Montano added.
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