The U.S. Department of the Treasury will begin an orderly wind down of its remaining portfolio of $142 billion in agency-guaranteed MBS. Beginning this month, it plans to sell up to $10 billion in agency-guaranteed MBS per month, although this would be subject to market conditions.
According to JPMorgan Securities analysts, the sale will be aside from portfolio paydowns now averaging roughly $3 billion per month.
They added that the Treasury's purchases were funded with bills and notes. This reduction should lead to less debt issuance in 2011 and 2012. The Treasury also stated that this sale is unrelated to its GSE portfolio policies.
Together with the paydowns, the Treasury's sales amount to a net monthly transfer of $13 billion of agency MBS to the market, JPMorgan analysts said. To put this in perspective, the Federal Reserve's portfolio's run-off is now averaging $12 billion to $13 billion per month, they noted.
Effect on MBS Market
The Fed paydowns were as much as $30 billion in Dec 2010, JPMorgan analysts said. The future run-offs and sales from Fed and Treasury portfolios together will total around $25 billion to $26 billion per month. This is higher versus the last month, although still less than recent peaks, JPMorgan analysts said.
Most of Treasury's holdings are seasoned specified pools. Sales of this magnitude in the pool market will pressure pay-ups, according to analysts. They added that given the breakout of Treasury's portfolio holdings of FNMAs versus FHLMC Golds, the Treasury's announcement is negative for Gold/FNMA 4.5s and 5s swaps. On the other hand, they think this is a positive for the 5.5s and 6s swaps.
Meanwhile, Barclays Capital analysts said that for the agency MBS basis and the coupon stack, the $120 billion of added supply a year is considerable, particularly in a year when net agency MBS supply was otherwise so low. This is why analysts turned neutral on the agency MBS basis, from their current overweight recommendation. Aside from this, most of the Treasury's holdings are concentrated in the 4.5s to 5.5s.
JPMorgan analysts summarized that the market implications are: negative for the basis although the effect is more on coupon swaps versus on the par coupon; negative for higher coupons; positive for 15/30s; positive for GNMA/FNMA swaps; positive for Gold/FNMA 5.5s and 6s; negative for Gold/FNMA 4.5s and 5s swaps; and negative for specified pool pay-ups.
Barclays analysts said that this move does not mean that the Fed will also begin selling its MBS holdings in the near term. They think that there is "no signaling effect for monetary policy" from this Treasury announcement. The Treasury had most likely consulted with the Fed on the market effect of this announcement, but that only indicates that both the Fed and Treasury think that any market effect will be muted, researchers said.
Purpose of Selling
According to the Treasury, the sale of these securities is part of its efforts to wind down emergency programs that were put in place in 2008 and 2009 for financial stability and restore economic growth. On October 3, 2010, new Troubled Asset Relief Program (TARP) purchasing authority expired, and the Treasury is moving to exit its remaining TARP investments in private companies.
A question, Barclays analysts said, is whether the Treasury is selling MBS to create room in case the debt ceiling negotiations fail. Analysts said this is unlikely citing the Q and A that the Treasury released regarding this announcement that said that this selling had nothing to do with the debt ceiling.
The Treasury now owns $142 billion worth of agency MBS, $150 billion in TARP investments, and $400 billion in student loans, for a total of close to $700 billion, analysts noted.
If the debt ceiling negotiations fail, the Treasury can buy time by stopping payments to the Social Security and Medicare Trust funds, and by selling their existing holdings. However, analysts projected that the Treasury needs $25 billion to $30 billion a week to fund itself, if the debt ceiling is not extended. The $10 billion a month in selling will buy them an extra week after three months of selling. This, according to analysts, is not sufficient to have an effect if debt ceiling negotiations fail.
Publicly stating that the Treasury will only sell $30 billion in the next three months can be taken as an indication that the Treasury thinks that the debt ceiling will be extended, and extraordinary measures including selling the entire MBS portfolio in a few months will not be necessary, Barclays analysts said.
The Q and A also emphasized that this announcement had nothing to do with housing finance reform, or the proposed wind-down of the GSEs. In addition, the Treasury noted that this announcement will have no impact on the U.S. government's commitment to supporting the GSEs' ongoing obligations.
The $10 billion per month in agency MBS equals an added $5 billion in 10-year Treasury equivalents hitting the market. By Barclays analysts' estimate, the total duration supply is approximately $250 billion per month in 10-year equivalents, which includes Treasurys and spread products.
An added $5 billion, they said, is unlikely to matter one way or the other. If buyers take this as the first sign the accommodative policy stance is over, then the effect could be considerable. However, analysts think this move has nothing to do with monetary policy, and we expect investors to believe the same.
“We’re continuing to wind down the emergency programs that were put in place in 2008 and 2009 to help restore market stability, and the sale of these securities is consistent with that effort,” Mary J. Miller, assistant secretary for financial markets, said. “We will exit this investment at a gradual and orderly pace to maximize the recovery of taxpayer dollars and help protect the process of repair of the housing finance market.”
The Treasury bought its portfolio of agency-guaranteed MBS under authority provided to it by Congress under the Housing and Economic Recovery Act of 2008. These agency-guaranteed MBS purchases helped preserve access to mortgage credit and promote economic stability in a time of unprecedented market stress and volatility.
The Treasury said the agency-guaranteed MBS market has improved much since the time it bought these securities in 2008 and 2009. Based on current market prices, the Treasury expects to make a profit for taxpayers on this investment. The sale of these securities will not alter our previously stated debt management objectives, nor change the path on which we intend to achieve those objectives.
In 2008, the Treasury retained State Street Global Advisors to acquire, manage, and dispose of its agency-guaranteed MBS portfolio. That firm will manage the wind down of this investment. At the end of each month, Treasury will post on its Web site the total agency-guaranteed MBS sales it has made, broken down by coupon and agency.
To access the Treasury's Q and A please click this link.