Rising MBS supply has been worrisome for the market, especially in light of the uncertain demand for the product. However, experts still believe that there is sufficient demand for the supply to be absorbed.
In a recent report, JPMorgan Securities analysts noted that the numbers show there is still enough mortgage demand to match the increased supply. For one thing, even though monthly 30-year agency net issuance has increased to around $30 billion from $20 billion to $25 billion last year, 15-year issuance has actually dipped. Analysts calculated that the drop leaves only approximately $25 billion that needs to be absorbed.
Based on the trade deficit and foreign purchases data, analysts estimated that overseas investors are absorbing about $17 billion per month in agency MBS. Meanwhile, analysts also reported that banks are growing their securities portfolios by between 5% and 10% per year. Based on current portfolio levels, this equates to about $70 billion of net purchases per year, or $6 billion per month. This leaves a modest remainder that total return and hedge funds should easily be able to absorb, especially with the current wider OAS levels, analysts said.
Lehman Brothers added that the Mortgage Banker Association's Fixed-Rate Mortgage Composite Index - a traditional gauge for estimating supply - might be overstating current mortgage volume.
Since April 2006, the Fixed-Rate Mortgage Index has been up 26% based on the Refinance Index rising 35% and the Purchase Index remaining flat. Analysts said that much of the increase has occurred relatively recently. Lehman analysts find the timing puzzling since it doesn't seem commensurate with the realized level of fixed rate activity. Based on the current level of the Fixed-Rate Mortgage Index, monthly agency issuance should increase by $90 billion to $100 billion (gross) not by the current $60 billion to $65 billion rise.
Analysts believe the MBA's Indexes are being influenced by several factors. These include ARM-to-fixed refinancing and borrowers taking out fewer loans, despite filing more applications, which is partly a function of tighter underwriting standards. There is also the factor of overstatement, particularly as a result of the subprime market's share declining, as only those applications from originators responding during the reporting period are counted.
Currently, Lehman analysts are projecting about $780 billion in gross issuance over the next year and $200 billion in net issuance, assuming zero percent home price appreciation and no rate incentive. Assuming there is a 3% HPA with no incentive, analysts expect net issuance to be about $50 billion higher from the base.
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