Convexity, convexity, convexity. That's all mortgage-backed securities players are talking about in this pre-holiday, gift-buying season. And one thing is for certain: the mortgage market's convexity is at an all-time low. It makes perfect sense: when you have a rapid rally, durations shorten and mortgage delta hedgers - that's MBS lingo for people who compensate for short durations by taking off some of their short by buying back Treasurys - have a much bigger demand for duration. But whether they're taking off their shorts or not, the word of the day is undoubtedly, convexity.

"The mortgage market's convexity sucks," said one straight-to-the-point investor. "Perhaps mortgages are outperforming Treasurys because swaps are in so dramatically, but mortgages have been the last boat in' recently. Lots of dealers use the 10-year to hedge their mortgage books, and buying begets buying, and selling begets selling."

"And so much more of the mortgage market is being hedged with swaps and agencies that there is a tightening to swaps and agencies versus Treasurys, because there is more demand in those sectors than in Treasurys," commented another astute MBS researcher. "Market convexity is as bad as it was in 1998, and it will continue to get worse until 6.5s are refinancible."

And so it seems like the only event that can shock this market in the next few months is if refinancings are below expectations. The housing market is not as strong as it was seven or eight months ago, and more of the market is levered. "I would not be shocked if prepayments are slightly below expectations in premiums," the researcher added.

But all indications point to a Refi wave for next year, or at least a big ol' wave of refis. Last week's important news was the release of the weekly MBA Mortgage Application Survey. The Refi index, in particular, rose 14% in the latest week as mortgage rates fell the week prior on the Greenspan-inspired rally. Last Monday and Tuesday saw some back-up in rates, though it was more than wiped out later in the week.

And of course, another buzz word in these last few weeks are "servicer buyouts" (see story page 1). Ginnie Mae premiums are coming under pressure because of servicer buyouts in the premium sectors. In premiums, servicers buy out the loans at par, getting borrowers current, and then selling them back in at a premium. Therefore, they select borrowers who they feel confident they can bring current.

Apparently, HUD has been promoting these programs and they pay the servicer $500 to do this. So it certainly makes economic sense for servicers to do that. Additionally, these FHA borrowers pay insurance premiums of 50 basis points, but with the home price appreciation we've seen, their LTV comes down to 80% in many cases, and the borrowers qualify for conventional loans. If they qualify, they refi out of FHA loans into conventionals to get rid of mortgage insurance premiums - which also affects moderately-seasoned Ginnie Maes!

All of this adds up to bad news for Ginnie Mae premiums, so that is something to keep your eye on during the new year.

Well, the holiday season is here, and this journalist has far too many thoughts about delta hedgers and convexity in his mind, usurping the place of good holiday cheer and thoughts of a much-needed vacation. That being said, Mortgage-Backed Securities Letter is being taken to the next level in the New Year, offering three times the amount of securitization information as it is merged into Asset Securitization Report. We at MBSL hope that you have a healthy and happy holiday break, and we look forward to serving your MBS needs in 2001 and beyond.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.