At the start of the year, supply/demand technicals were deemed generally supportive to the market, despite the Federal Reserve's impending exit. Net issuance was estimated at around $320 billion for the year with the Fed's final-quarter purchases totaling $139 billion.
Many MBS analysts, however, have since revised their supply outlook downward. So far through March, net issuance of Fannie Mae, Freddie Mac and Ginnie Mae totals negative $38.6 billion, impacted by the GSEs' delinquency buyouts. Negative net issuance is projected again in April as GSE issuance is expected to remain negative, with only Ginnie Mae positive. Outside of the delinquency buyouts' impact to supply, refinancing activity has been and remains muted as a result of the declines in home prices, the tight lending standards and poor labor market conditions - despite fixed mortgage rates near record lows and affordability conditions remaining very favorable.
Bank of America Merrill Lynch analysts also believe the regulatory reform legislation the government is working on "is effectively code for slowing down the flow of credit to the economy" to prevent the laxness that occurred in 2005-2007 and that led to a substantial increase in non-agency RMBS issuance.
Credit Suisse analysts are projecting net fixed rate supply for agency MBS overall at $60 billion compared to $120 billion previously. With the inclusion of agency ARMs issuance, they predict zero net agency issuance.
JPMorgan Securities analysts reduced their net supply outlook to $270 billion from $300 billion with an "adjusted" net supply of zero after factoring in the GSE delinquency buyouts.
Deutsche Bank Securities analysts, after adjusting for the buyouts, estimated that net issuance for the first half of 2010 could be negative $50 billion and reach just $100 billion in the second half of the year. Finally, BofA Merrill analysts expect net RMBS issuance to total $105 billion, and to be $255 billion after including all securitized sectors - consumer ABS, CMBS and non-agency RMBS.
Demand Outlook
As 2010 embarked, many participants were concerned about spreads gapping out substantially wider because of the Fed's exit. Current coupon OAS' have widened 20 to 30 basis points. However, it has been more volatility-driven. Nominal spreads to 10-year swaps and Treasury notes also have widened from mid-50 basis points in February/March and have been ranging between 60 and 70. Spreads, however, are expected to trade in a relatively tight range over the short term given the supply/demand outlook, and many investors see the 70 area as an attractive entry point.
Speaking of demand, JPMorgan analysts anticipated strong demand from banks for MBS to emerge. Factors playing into the pickup are declining loan holdings against strong deposit levels, excellent liquidity, essentially no credit risk and attractive carry in the steep yield curve environment. They added that the GSE buyouts will put around $50 billion in cash that needs to be reinvested with overall expectation that banks will buy roughly the same amount as in previous years of around $100 billion. Credit Suisse analysts also said that, because of the lack of alternatives, banks should remain MBS buyers. Analysts estimated net demand from banks for 2010 at $90 billion.
While banks have been limited in the first quarter, BofA Merrill analysts think that as issues associated with FAS 166/167 capital charges are worked through, as their capital bases improve as a result of earnings growth and as worries associated with the Fed's exit fade, banks will become more active in the agency MBS market and will be the next set of marginal buyers along with overseas.
