A holiday and a Presidential Inauguration garnered market participants' attention into midweek. In addition, activity remained limited on Wednesday as investors waited for more information on the new administration's plans to deal with the latest escalation in bank problems as well as a contracting economy.
There were more bank failures. Royal Bank of Scotland warned that worsening conditions in the fourth quarter could result in a $41.3 billion loss for 2008, which led to further support from the U.K. government. It said write-downs could total nearly $12 billion for the year. Citigroup also cut its dividend rate to a cent from 16 cents following its $8.29 billion net loss for the fourth quarter and $18.72 billion loss for the entire year. Its stock price was trading around $3.00 a share in the early week with talk of nationalization swirling around the markets.
In light of all these, MBS volume was below normal in mixed flows. Unlike the previous week, down-in-coupon was outperforming into Wednesday's trading session. Aside from the Federal Reserve support in lower coupons, servicers were also reportedly moving down in coupon. At the same time, supply calmed down a bit to $2 billion - split about evenly between 4% and 4.5% coupons.
Other investors, meanwhile, were two-way with a bit more interest showing on the improvement in price levels. The mortgage market price was at an average of $103.51, according to Barclays Capital, down from nearly $104 in the Jan. 12 week, helped by a Treasury sell-off related to supply worries. Through midday on Wednesday, the 10-year Treasury had lost over 50/32nds since the previous Friday's close.
Month-to-date through Jan. 20, Barclays MBS Index had outperformed Treasurys by 78 basis points. This compared to 659 basis points for ABS, 167 basis points for corporates and negative 612 basis points for CMBS.
One of the factors providing support for mortgages is the more than $5 billion on average in daily buying from the Fed and Department of the Treasury. At the same time, any firming in price levels will likely lead to profit taking by many real money investors, while supply is also ramping up. Still, Barclays Capital analysts remained overweight last week based on expectations that government buying will absorb the net supply, and this, combined with other investors buying, tips the supply/demand balance in favor of MBS.
Prepayments are expected to surge in the January report in response to the surge in refinancing activity in December due to the sharp drop in mortgage rates. Agency MBS pay-downs are projected to total more than $90 billion compared to $45 billion in December.
According to a consensus, speeds in our sample are expected to increase 138% on average in 5s through 6.5% - an 11 CPR increase. Further, speed increases in 5s through 6s are all expected to increase more than 100%, while 6.5s and 7s will see smaller percentage increases. The sharpest increases are projected in 2007 and 2006 vintages.
Anecdotal information on issuance to date, however, suggests that speed increases could be less than projected. Deutsche Bank Securities analysts point out that gross issuance this month through Jan. 15 for the GSEs has come in below that of the last few months for the same period. Data going back to 2006 shows that generally around 80% of combined 30- and 15-year issuance is received by the 11th business day.
"If an 80% figure is applied to January, the total issuance for the month would be quite low," analysts said. "Higher prepayments should cause gross supply to be elevated, and the low issuance for Jan. likely indicates anemic upcoming prepayments."
Further supporting an anemic prepayment outlook is the coupon distribution, Deutsche analysts said. They said heavier volume in 4s though 5s should be seen if prepayments had been large. Month-to-date in January, they show $1.3 billion in 4s, $7.6 billion in 4.5s and $9.3 billion in 5s. This compares with $0, $5.3 billion and $19.7 billion, respectively, for these coupons for December.
Analysts suggested that if prepayments do come in severely low, the government could be pressured to adjust policies to encourage refinancing, such as the reduction or elimination of g-fees, waiving of reappraisal requirement or requiring banks to maintain a low primary-secondary mortgage spread. They believe, however, that the government would wait until the February report for further information.
Supply could come in strong toward the end of the month and/or default prepayments could show, analysts said, which would lead to higher prepayments than the anecdotal information indicates currently. If default prepayments pick up, they would be concentrated in the higher coupons/credit-impaired collateral.
At this time, speeds in February are predicted to increase close to 50%, while March gains are slight. March speeds are currently expected to either remain almost the same or slower in 5.5s and higher, while 5s and 4.5s will experience the largest increases.
GNMA speed increases are more moderate at around 50% higher from December. Speeds in December were much stronger than conventionals and were likely a result of servicer buyout activity, Deutsche analysts said. In this event, it would take some time to rebuild the pipeline of delinquent loans, so less of this action could be expected in the upcoming report.
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