With Freddie Mac significantly growing its forward commitments in March, MBS players have been granted some comfort, although analysts said the efforts would mean little if the agency's recent investment patterns continue. Furthermore, Fannie Mae's portfolio decline is still hovering over the market.

"Activity out of the GSE portfolios remains one of the biggest stories for the mortgage market, with the two portfolios headed in opposite directions," said Bear Stearns analysts in a recent report.

Last week Freddie Mac reported that its net mortgage purchase agreements jumped to $32 billion - the biggest block of forward commitments since July 2003 - from $13.3 billion in February, although over half of these commitments were from a one-off deal and thus does not accurately reflect their core runrate, according to JPMorgan Securities equity analysts. Freddie also disclosed in its monthly activity report that non-agency securities rose by $13.1 billion in the first quarter while agency holdings dropped by $9.6 billion (see related story on p. 17).

Meanwhile, Fannie Mae has yet to comply with the September capital requirement deadline set by the Office of Federal Housing Enterprise Oversight and has been dogged by rumors of continued portfolio selling, particularly at the beginning of the year. Last Thursday Fannie reported that its gross mortgage portfolio shrank to its lowest level since July 2003 ( see related story on p. 18). Bear Stearns analysts also said broker/dealers need to find homes for the supply that Fannie previously bought under more normal circumstances as well as for the mortgage-backeds that Fannies is said to have sold - a search that Bear Stearns characterized as "bumpy."

So far the current supply/demand situation that the GSEs have played a huge part in have not affected market spreads. JPMorgan analysts said, "technicals have overwhelmed relative value trading," with many investors characterizing the mortgage market as broken.' For instance, even with both GSEs steadily selling agency MBS and overseas purchases and net bank activity decreasing, spreads have held near record tights.

Although spreads have held steady so far, Lehman Brothers analysts note, "the biggest concern on the demand front is the weakening of the back-stop bid from the agencies, which increases the risk in owning mortgages from a liquidity standpoint." They noted that GSEs find fixed-rate mortgages unattractive and highlighted their capital constraints as well.

Commercial banks are not much help either. "Banks could play spoil sport to a basis short, given the delivering trends on their balance sheets," Lehman analysts said, noting that these banks' balance sheets are flush with capital given the last four years' robust earnings resulting in overall bank de-levering. They reported that commercial banks can chose to return to late 2000 era leverage ratios and increase total assets to roughly $1.6 trillion, adding that the last year has seen $800 billion worth of de-levering as banks are uncomfortable taking on duration exposure with the Federal Reserve on the move.

Credit Suisse First Boston researchers report that although deposit growth rates have outpaced C&I loans thus far, the narrowing differential implies that future MBS bank sponsorship could continue at slower pace than previously. The report noted that year-over-year C&I loan growth has risen steadily to the 8% level, the highest since 2000. Deposit growth remains at 9% while mortgage exposure, including MBS and mortgage loans, has also increased with an annual 8.5% pace - the numbers reflecting a convergence of all three and "signaling a likely turning point in bank sponsorship for the MBS sector," said analysts. "Growth in MBS holdings has mirrored the differential between deposit and commercial and industrial loan growth with trends in peaks and troughs coinciding," CSFB analysts wrote. "Notably, as this net difference has converged, the growth rate in bank MBS holdings has commensurately declined." Analysts clarified, however, that this does not indicate imminent bank mortgage selling, citing history. For instance, despite prolonged slower deposit growth relative to C&I holdings over the late 1997 and mid-2000 period, growth in MBS holdings decreased only briefly into negative territory, according to CSFB researchers.

JPMorgan added that despite the $30 billion Megas produced for April settlement - backed primarily by FNMA 5s and 6s - there was a $9 billion drop in net bank MBS holdings the week ending April 13, which is unusual if not on a paydown date. Thus JPMorgan concludes that April net bank purchases appear modest, if not negative, adding that some of the April super Megas were probably not for banks and there also might have been selling in excess of bank purchase activity.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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