The Federal Reserve and the Obama administration have put the continued poor state of the housing market front and center on their agendas in the first month of 2012 and now into early February.
In a letter issued in early January to leaders of the Senate Banking and House Financial Services Committees, Chairman Ben Bernanke stated that "restoring the health of the housing market is a necessary part of a broader strategy for economic recovery."
Accompanying the letter was a white paper entitled The U.S. Housing Market: Current Conditions and Policy Considerations.
The state of housing no doubt weighed into the Federal Open Market Committee's (FOMC) decision in late January to announce that economic conditions "are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014".
The FOMC also reiterated its statement that it would "regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate." However, it was extended with "to promote a stronger economic recovery in a context of price stability," which many took as increasing the odds of QE3.
Meanwhile, President Obama is focused on increasing his odds of getting re-elected and has been busy as well with new initiatives, around three so far.
Last Friday, the U.S. Treasury and the U.S. Department of Housing and Urban Development announced an extension of the Home Affordable Modification Program (HAMP) for an additional year through 2013 to try to reach more homeowners who might be eligible; the expansion of eligibility requirements; the increaase in incentives for investors who agree to reduce principal for borrowers; and the extension of financial incentives to Fannie Mae and Freddie Mac to reduce loan principal. The Federal Housing Finance Agency (FHFA), however, has to agree to the program before the GSEs can participate.
On Wednesday, the FHFA announced an "REO Initiative" that will allow qualified investors to purchase pools of foreclosed properties to rent-only for a specified number of years. The press release said that during the pilot phase, Fannie Mae will offer pools of various types of assets for sales including rental properties, vacant properties and nonperforming loans primarily focused in the hardest hit areas of the country. The first transaction will be announced in the near term.
Also on Wednesday, the president asked Congress to pass legislation that would allow non-GSE borrowers with (Federal Housing Administration (FHA) level) conforming loan balances to refinance into an FHA loan. Borrowers to qualify must live in the residence; be current on payments within the last six months and to have missed only one payment in the six months prior to that, and their FICO score could be no lower than 80.
The Administration said that the cost of this would be paid for by a portion of a proposed fee on the largest financial institutions based on their size and risks of their activities. For GSE borrowers, streamlined refinancing would be extended for borrowers who have LTV's below 80%. Currently, only borrowers with LTVs greater than 80% are eligible for Home Affordable Refinance Program (HARP).
All of this, of course, follows on FHFA's announced changes to the HARP last November which have yet to be reflected in prepayment speeds.
Higher Coupons Unfazed on Obama
This latest push to help underwater borrowers refinance had limited impact on fuller coupons as it was seen primarily as a re-election ploy since the makeup of Congress makes it difficult to get legislation passed. Higher coupons also were seen as having an adequate risk premium built in and investors were buying up in coupon following recent cheapening despite the headlines.
There was active buying in lower coupons as well from money managers, banks, hedge funds, as well as, the Fed over the week that by Thursday's close had brought prices on FNMA 3.5s through 4.5s to new record highs of 104-02+, 105-25, and 106-28+, respectively, according to Tradeweb.
Investors were encouraged, despite higher prices and tighter spreads, by the prospect of low rates into late 2014, attractive carry, and favorable odds of QE3.
In other mortgage-related sectors, specified pools were active with good demand for call protected paper from banks, REITs and money managers; 15s mostly lagged 30s with the curve slightly flatter, while GNMA/FNMAs were mixed with limited overseas interest in GNMAs as prices rose.
Tradeweb volume through Thursday averaged 146% for the week compared with 130% as activity was spurred by lower 10-year note yield levels, record prices, heavier supply and various headlines.
For the month of January, excess return on Barclays Capital's MBS Index was 13 basis points. Mortgages lagged by a wide margin ABS (+84), CMBS (+164) and Corporates (+165).
So far in February, mortgages are off to a positive start at +6 basis points. The 30-year current coupon yield declined to 2.76% from 2.84% with the spread to 10-year notes tightening to 10 basis points to +84.
Supply/Demand Prospective
While Friday's stronger-than-expected employment report led to a sharp sell-off and selling from money managers and fast money, odds were not seen as too dented in regards to QE3 at this time as the debt crisis in Europe remains alive and well.
Still, this report followed on a larger-than-expected decline in Initial Claims, the January non-manufacturing index jobs component portends more strong NFP prints.
As a result of lower mortgage rates, supply steadily ramped up to around $2 billion per day on average from $1.6 billion last week.
Originator selling was largely concentrated in 3.5% coupons. Regarding the largest demand source currently, the Fed, its MBS purchases totaled $6.25 billion over the week ending Feb. 1. This indicates that Fed coverage in the mid-60% area. Investors were favorably disposed to absorb the excess given the sector's favorable outlook, particularly the QE3 backstop bid.
The Federal Reserve Bank of New York will announce next Friday its planned MBS purchases for the four-week period beginning Feb. 13.
With prepayment speeds expected to be slightly slower in January from December, the amount of paydowns the Fed will have is likely to be somewhat lower than the $25 billion for this current period. The Fed, however, still has an estimated $7+ billion left to purchase over the next week, which averages to around $1.2 billion per day.
Today's sell-off helps provide improved entry opportunities for investors, especially with reinvestment of January paydowns looming. There is the potential next week as well for further price concessions as Treasury is scheduled to auction $72 billion in three- and 10-year notes and 30-year bonds beginning Tuesday through Thursday.
Investors, however, may be more inclined to require more than a "shallow dip" to add to their holdings with the Fed's buying somewhat tempered by its paydowns, while more supportive reports on employment may push QE3 odds down. Having said that, next week's economic news calendar is very light, and so Europe looks to be the primary reason for this event aside from supply.
Prepayment Outlook
Prepayment speeds are projected to slow around 2% to 3% on average in January for 30-year conventional and GNMAs and 15-year FNMAs in IFR Markets' sample.
Paydowns are estimated at $108 billion. Month-to-date gross issuance stands at $108 billion, which puts net issuance at unchanged for the month. The report will be released late afternoon this coming Monday.
