It has been a very "interesting and eventful week for mortgages," market participants said, as 15-year paper made an incredibly strong showing and Ginnie Mae paper made a significant comeback.
Dwarf 7.5% 15-year paper was simply a phenomenon last week, outperforming 30-year paper on the week by 10 ticks, while the 30-year current coupon was down four to five ticks, market sources noted. All of this was purportedly due to a strong roll in 7.5's, and a big squeeze in that coupon. This 15-year paper "decoupling" had some market players believing that valuations for this paper were crazy and/or out of control, though some observers thought that valuations were sensible.
"There is a big squeeze on 7.5's," said David Montano, head mortgage researcher at Credit Suisse First Boston. "But it will clear up a bit next month, since the current inverted yield curve and not much refinancing activity drives 15-year production down. But mortgages generally performed even across coupons, though 30-year collateral was weaker versus Treasurys but stronger versus swaps on the week."
Ginnie Maes have also been doing very well. Most collateralized mortgage obligations done are Ginnie Mae deals because Ginnies were cheap versus conventionals and banks were interested in leveraging their balance sheets by buying Ginnies, which have a lower risk weighting. Ginnies, therefore, drove CMO activity. However, there has been no significant foreign buying of Ginnies, sources say, and the agency's well publicized plan to have its own portfolio by October 2000 was completely shattered when that plan was not included in this year's HUD budget.
Fed Reserve Chairman Alan Greenspan's speech to the Senate and House during the past weeks has caused a small debate among mortgage market players regarding whether it portends a slowdown in housing activity.
"I think it will have a negative impact on mortgages because of extension risks, and investors are starting to see that up-in-coupon trades are safer," Montano said. "However, there have only been sporadic up-in-coupon trades, mainly because the mortgage index is weighted toward 6.5's, and investors don't want ratings that are different than the index.
"There is less extension risk in the 15-year paper. There will be a slight pickup in February and a bigger blip in March, but if that doesn't happen, discounts will get battered."
Controversial IRS Proposal
There has been a tremendous amount of speculation last week about a controversial IRS proposal about Remic residuals that would make dealers liable for taxes on residuals. The IRS has set up a formula for how much residual cashflows are worth. Because of recent problems with residuals being transferred to off-shore accounts, the government has been cracking down, and could possibly make dealers pay more than twice what they are currently paying.
According to market sources, if the proposal becomes law, "it will add two ticks to the cost of doing a Remic, and in the current environment that could cut out CMO activity completely."
"But there's only a slim chance that this will pass, and it will be fought tooth and nail by both the agencies and the dealers," said one source. Additionally, the law would be retroactive to February 4, so dealers would be responsible for CMOs that are done right now.
"Two ticks is serious money, especially with the fact that profit margins are low on Remics right now," said the source