After two record years of mortgage-backed security issuance, the numbers have started to return to Earth. Higher interest rates are mostly to blame, while low Ginnie Mae supply has also contributed to the sharp decrease.

According to The Bond Market Association, MBS issuance for the first quarter of 2000 was $89.5 billion, a 61.7% drop from the $233.8 billion for the first quarter 1999. After seeing total issuance over 1998 and 1999 at over $700 billion and just under $700 billion, respectively, the Association says numbers like that will be hard to beat.

"So I think to sustain those levels is going to be difficult, just coming on the heels of record issuance years," said Stephanie Mah, a researcher at the Association. "I think that, combined with a rise in interest rates, is causing a slowdown in the housing market." Less origination will lead to less issuance, she added.

Dale Westhoff, a managing director of MBS at Bear, Stearns & Co., said that Bear had projected at least a 50% drop over last year's numbers. "Really since January, we were projecting issuance for 2000 to be around $220 billion, and actually, for Fannie Mae and Freddie Mac fixed-rate issuance, it's running around $20 billion a month," he said.

A rise in interest rates leads to a decline in refinancing activity, which also has contributed to this year's swoon. "If you take a look at the total refinancings and first-time mortgage applications, they're probably going to be off year-to-year in the first quarter," said John Lonski, senior economist at Moody's Investors Service. "That may help explain part of the decline."

Lonski added that widening spreads throughout the time period, in which the 10-year swap spread widened to 112 basis points in March, from 96 basis points over in February and 85 basis points over in January, played a role in declining issuance. "It may have been that some of the mortgages that were originated late last year and early this year, that their yields were not really high enough to make it profitable to repackage these mortgages into MBS, because of the fact that you did have this spread widening," he said.

In addition, Westhoff stated that Ginnie Mae issuance was expected to be $80 billion for the year, down from $138 billion last year. But because of the Federal Home Loan Banks' buying a large amount of Federal Housing Administration loans for its MPF program - which account for 70% of Ginnie Mae securities - the numbers were revised to $70 billion.

"In terms of relative value, we feel the Ginnie Mae sector is very rich at this point and we generally favor conventionals and up-in-coupon trades with extension a kind of concern in lower 6% to 7% type coupons, which is kind of an ongoing story," he said.

Seasonal downturns were also considered when justifying the numbers. "Not many people are buying a house in November, December and January to close in January, February or March," said Art Frank, head of MBS research at Nomura Securities. "So we expect a modest pickup of conventionals in the second quarter and third quarter because seasonally there are more people closing on homes they're purchasing."

"You're going to get your normal seasonal effects, and we're seeing the peak of that effect right now, and after August, we typically trail down as we pass through the peak homebuying season," added Westhoff, who said this year's numbers will be more reflective of historical averages.

Despite lower issuance, MBS is still attractive and "there still is demand," Westhoff said. "From a fundamental perspective, it's a good time to own MBS, because we're in a higher interest rate environment, so we expect very low prepayment volatility and typically mortgages perform very well in this kind of stable prepay environment."

And Frank sees more issuance this summer. "There should be a decent amount of issuance over the summer, but Ginnies will continue to lag because the FHLBs continue to soak up a lot of the FHA loans," he said.

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