As year-end approaches, a seasonal slowdown in both supply and demand is leaving the mortgage-backed securities market fairly quiet. Spreads have widened a bit over the week, while technicals are expected to perform strong.
Spreads among 10-year Fannie Maes have widened to 144 basis points over the 10-year Treasury from last week's close of 141 over. However, over the 10-year swaps and 10-year benchmark agencies, the spreads have tightened slightly to their three-month average. "They're pretty much at the average relationship, so the mortgage market as a whole seems fairly valued," said Art Frank, director of MBS research at Nomura Securities.
However, he noted that at Nomura, they tended to overweigh the market this week, as the technicals were expected to be pretty favorable.
A report issued by PaineWebber also liked the market technicals. "Mortgage technicals remain excellent, with limited supply and heavy bank demand," the report stated.
"Even as the demand may diminish as we go through towards year-end, so will supply, in the extent that demand bounces back in January, there won't be a lot of supply of mortgage-backed then, either," said Frank. "So the supply-demand situation is pretty favorable for mortgages even though in fundamentals they're fairly valued rather than cheap."
Among passthroughs, a mortgage-backed securities trader has said they have performed "Okay," favoring the 20-years over the 15-years, and noting that the 15-years seemed "extremely expensive."
The trader indicated that there is very little to discuss among passthroughs, though the "general environment for mortgages is pretty positive, and I expect things to kind of slowly do well for the rest of the year," he said. "People kind of missed the boat on some of the rolls in August and September when you could have bought 8s for January delivery at essentially somewhere in the neighborhood of 4% cost of funds, and that's not available any more."
"The best way for many mortgage portfolio managers to express a duration bet is to move down-in-coupon within the mortgage market," said the PaineWebber report. "That leaves the higher coupons cheap."
Let's Talk Relative Value
At Nomura, conventional high-premium 8.5s are favored, while in Ginnie Maes, the analysts favor the deepest discount 6s and 6.5s. "Those are the sectors of the market that our model has having a double digit Libor-OAS," said Frank.
However, the trader suggested that the 8s have had their run, and, while it was good, the trade is probably over. He suggests conventional 7s, while suggesting that 7.5s are not very attractive. "I like 8s better than 7.5s. I think 7.5s look rich, but I think marginally, 7s are the best place to be," he said.
IO Deal Looks Cheap
A Bear, Stearns & Co. excess servicing IO deal (MBSL 11/8/99) using Fannie Mae collateral was profiled this week in the PaineWebber report. They stated that market participants have kicked around three possible motivations that may prompt future sales of servicing, including recognizing accounting gains, avoiding difficulties on accounting for servicing hedges that will arise with FASB 133 and freeing up capital.
"Beyond the security value of Trust 305, the market needs to assess whether similar servicing can be expected in the future," the report stated. The report concluded that the deal seems a little cheap, and its future supply picture is "murky."
However, PaineWebber analysts did note that accounting issues could be important in bringing new supply of IO cash flows to market.