Markit's new synthetic total return swaps ndex — Markit IOS Index — appears to have seen good participation on its first day, Barclays Capital analysts said.
The initial launch consisted of sub indices referencing the interest component of FNCL 2009 vintage 4s, 4.5s and 5s. Additional sub indices, including for FHLMC Gold and GNMA, will be launched on a semi-annual basis with the next date scheduled for Sept. 12.
According to Markit marketing materials, a long position on the index replicates the purchase of the interest component of an agency pool funding the transaction at Libor, while a short position pays the coupon on the index on swap notional.
While other attempts at new agency MBS products have had limited success, RBS Greenwich analysts believe IOS have a better chance of success.
Among some of its strengths they noted are strong dealer support with 10 market makers on board so far; as a derivative, IOS is less capital-intensive than a cash investment; there are no size limitations as it is a synthetic; it may trade more efficiently than cash IOs as IOs do not result in a PO creation; and it should attract new macro-oriented investors.
Regarding the latter, Deutsche Bank Securities analysts added that aside from "providing an excellent hedging vehicle to servicers to manage their prepayment risks, the indices also provide (macro) investors an instrument for expressing their views on the mortgage basis and the direction of prepayment speeds."
They also believe the indices could be useful for the GSEs to hedge cashflows in their guaranty book of business.
Still, Deutsche analysts noted that the product's success and liquidity rests particularly on the dealers' willingness to take the opposite side of the trade from servicers and GSEs, which are natural sellers of these new indices.
Weaknesses of the product that RBS cited include counterparty risks, pricing of the IOS might not reflect cash IO market or fundamentals, and lack of cash delivery option further disconnects pricing from cash markets.
