MBS DAILY WRAP: Another Day, Another Rally, Another Move Down In Coupon

By: Matthew Graham •

(EDIT: maybe we were too big for our own breeches, well at least our charts were.  Several of the charts below are cut off prematurely on the right hand side.  To get a full view between now and the time we edit them you can simply right click a graph, select "copy image location," and paste that into a new web browser.  Sorry for the inconvenience)

 

Yet another triumphant day for MBS.  Spreads have been meandering down a tightening road, but today the proverbial "Meep Meep" was heard from MBS shortly before they left old Wile E Treasury in the dust.  To put things in perspective, the 10 yr tsy DROPPED 12/32nds, whereas the 4.5% coupon GAINED 24/32nds.  Bad day to be watching that good 'ol 10 year eh?   This brings up a good opportunity for a paragraph on "speeds."

In order to get a relevant basis for comparison from MBS space, we have to find an MBS coupon that "lasts about as long" as 10 years.  Remember that there is no set time limit on MBS other than the mortgage note.  If people want to keep them all 30 years, they can.  But of course, they don't.  The question of "prepayment speed" is central to the concept of MBS analysis.  This is commonly referred to as "speeds."  It encompasses refinances, sales, foreclosures, etc...  For mortgage brokers in particular, it's important not to confuse anything about a "prepayment penalty" with "prepayment speeds" (though penalties are gradually becoming a thing of the past it seems).  So if you hear us discuss "prepays," or "speeds" or CPR (constand prepayment rate), or "weighted avergage life," or "embedded call option" (since the borrower can 'call' the note by paying it off), we are concerned with how long the average borrower in a mortgage that underlies an MBS coupon will keep paying their mortgage.  One thing that might surprise some of you is that in the instance of foreclosure etc..., the secondary market investor is much less worried that the loan is defaulting because they are guaranteed "timely payment of principle and interest" and much more worried that the speeds they were anticipating are changing, so they might have cash that was locked in earning 7% all of the sudden in a market that's only paying 4.5%.  Lots of money gets lost that way.  Lots of banks go out of business.  And we see exactly what we've seen, which is mortgage spreads blowing out far past all time wides to account for the uncertainty in prepayment speeds. To conclude, we used a baseline of 10 year treasuries agains the 4.5% coupon because the prepayment speed on a 4.5 is roughly 10 years.  So to an investor choosing risk versus no risk, everything else would be apples to apples.  When the yields (rates) on mortgages go down faster than treasury yields, that's what we refer to as "tightening" (because the yield curves are getting tighter to each other).

So why all the tightening?

In two words: everyone bought!  All day long, servicers, banks, money managers, hedge funds, and Asia bought MBS steadily.  To make matters better for prices, we didn't see a lot of supply glut the market.  Last week's average of 3-4bln per day and today we were around half that.  To put things in perspective, during boom times last time rates were this low, our MBS trader friend at a wall street mega-firm reports things were more like 30-40bln PER DAY! 

So why was everyone a buyer?

Several reasons here...

  1. We haven't had any catastrophic mortgage drama over the past few weeks, so to a certain extent, the potential buyers who have been shell-shocked from repeated bombardments of headline risk are once again beginning to stick their heads back out of the shell. 
  2. Another thing that we would do well not to forget in times of rapid market movements is "the big picture," in this case spreads.  Spreads to treasuries and swaps remain at historical highs.  Sure, the first paragraph mentions how nicely they've come down, but this is only with respect to recent action.  Throwing out the past few months, they're still higher than they've ever been.  The "buying signal" here is that wide spreads equal opportunity for investors.  It means that sellers are saying "yeah, we know these things seem awful risky right now, but we'll pay you so much more than you could get from a treasury that you won't care."  Well, that "spread" between what an investor could get on MBS versus elsewhere had to get a lot higher than many expected before investors stopped caring about the risk (and they might not be done with the whole "stopped caring" thing yet either).
  3. The most important reason is the "roll."  We've been saying two important things for quite a while now.  First, market participants WANTED to buy MBS because of aforementioned spreads combined with increasing explication of the government guarantee, but COULD NOT due to that whole Credit Crisis thing.  Second, treasuries and cash look better on balance sheets at the end of the year, so we've been expected mortgages to get the short end of the stick.  Since the coupons rolled yesterday, the next delivery date is, yep, you guessed it, not until AFTER new year.  So everyone who was holding MBS as a seller got all squared up with buyers yesterday and were able to come back in as buyers.  They just happened to come back in much more than the market had "priced in" by way of expectation. 

One thing you'll notice in the "by the numbers" section below is that the lower coupons gained much much more than the higher coupons.  We've talked in the past about "down in coupon" movements and that as rates improve, this down-in-coupon movement is generally the case as there will be more of a market to trade in at those lower coupon levels.  But there was added impetus for the "down in coupon" move today.  FHFA director James Lockhard was out today saying GSE's are considering re-introducing our old friend the PIW (property inspection waiver).  For those that are unfamiliar, that would mean no appraisal requirement on certain deals.  Would this spur extra refinance activity?  Yeah it would.  What would that do to speeds on those higher coupons?  It would speed them up (people would pay off quicker as they refinanced more easily).  SOOO investors are not in a hurry to buy that higher coupon stuff for several good reasons.  Thus we see 4.5's gain almost a point versus 6.5's gaining nothing.

Another "in other news" tidbit regarding the earlier post about the treasury buying their expected amount of Agency MBS this month is that it accounted for over three quarters of all new issuance that was purchased.  This means that 3/4ths of all new MBS that came to the table were bought by or through the government.  Even the bailout naysayers have to stand up and take notice of the spread movement created by this massive participation. 

The economic calendar goes weekly tomorrow with our old friend Jobless Claims leading the pack.  Ecpectations there are for 525k loss.  A bit lofty, but not within the scope of recent reports.  Occupying that 830AM slot as well are import prices expected to be down 4.9% and international trade expected to be down 53.5 bln.  We get one Fed speaker, Stern at noon.  But perhaps the most impactful even will be the results of a $16 bln auction of 10 year tsy's.  The demand for today's treasury auction was slightly on the apathetic side.

Thanks for the novel Matt, but do I lock or float?

That's a pebble you'll have to snatch from our hands on your own.  It really depends on your scenario.  The fewer deals in your pipeline, the more you should be predisposed to lock.  The shorter the time horizon=same.  the higher the sensitivity of the deal for any other reason=same. 

We're also facing a bit of a ceiling with the 5.0 at 101-16 range.  Additionally, lenders are coming across as "booked up."  We saw reprices for the worse today due purely to lenders not having the capacity to accept additional locks.  What a shame... 

Other considerations...

  1. We've been on a tear recently.  Don't get me wrong, things will continue to improve generally speaking, but we will have to give some of that back in the short term.  I give you exhibit A which is an MBS chart going back to 2001.  you can see the gradual downtrend (rates were getting higher) leading into the recession, and now that the recession is here, we firmly believe in a gradual uptrend for oh so many reasons.  But note how the curve has spike recently.  We don't ever see that historically without at least some retracement.  it's not a question of "if," simply "when."  To edify that position, depending on which coupon you chart, we are at or near the "higher high" trendline.
  • Let's also consider the significant tightening in spreads today.  Spreads haven't had many 5 day runs where we've tightened the whole time.  It seems that we're riding the bottom of the uptrend, and although we will have a reversal, this risk for us spiking back up into the middle of the recent trend range is a real one.
  • Then there's our friendly neighborhood trend channel from yesterday.  With the exception of the little unpleasantness this morning, it held all day.  I bring this up not to say it's going to continue to hold, but rather that these things never hold this perfect of a channel for long.  We'll either break up or down, and down is more likely.
  • If the 3 preceding graphs weren't enough, there's more.  In these weeks between now and the end of the year "funding" is going to be important as buyers frantically try to get into MBS while still meeting their year-end cash requirements.  So Libor is important.  If we take a look at the 2 year and 5 year swap spreads (difference in yield between treasuries and the bond created by fixing the interest only cash flows of a libor obligation), we see the credit crisis appears to be getting better.  In fact, it's getting better far too fast for this market's psychology.  The risk of a correction (even though things will continue to improve generally) is quite high.

Here's the 2 Year (you'll see this is the most "spikey" because in the short term, counterparties have had no confidence that they'd get their money back from each other).  Oh yeah, we haven't broken our uptrend for short term money either!  (and notice that little Lehman Brothers Incident in September...  Sure it didn't cause the credit crisis, but it sure caused 'something')

Here's the 5 year.  You can see some stability finds it's way into this one, and slightly closer to breaking the negative credit trend:

Just for fun, let's take a look at a 7yr swap spread chart.  You can see an important triple bottom is broken as well as the uptrend in spreads.  Why, if one were to consult the 7yr, the credit crisis is over!  Or maybe counterparties just think it will be about 7 years before they can totally trust each other again.

  • For those of you that want YET MORE (Inconceivable!), here's some more "By The Numbers":

FNMA:                                                        GNMA                               15 Yrs

- 4.0 - up just over 1.5 points to 99-01                                               down 16 ticks to 98-27

- 4.5 - up 16 ticks to 100-11                        up 9 ticks to 100-23         up 12 ticks to 101-01

- 5.0 - up 10 ticks to 101-10                        up 14 ticks to 101-27       up 10 ticks to 101-28

- 5.5 - up 9 ticks to 101-29                          up 11 ticks to 102-13      up 7 ticks to 102-04

- 6.0 - up 5 ticks to 102-15                          up 8 ticks to 102-30        up a tick to 102-14

- 6.5 - up 2 ticks to 102-28                          up 7 ticks to 103-10

- dow up 70 to 8761

- EuroDollar down .08% to 1.3012

- Oil up .72 to 44.24

- bloomberg current coupon down .11 to 4.21

- MBS Index up .46 to 104.57

- In treasury space, Bloomberg says it as well as anyone.  Here's their US treasury breakdown.:

spread between 2's and 10 year treasuries on the day:

For reference 176 would be 176 bps or 1.76%

Also, since that 30 year yield is such a hot topic these days, here's how the 30yrs fared agains 10's on the day:

If you want yet more than that folks, I'm afraid I can't help you tonight.  The moral of the story? If you don't have overnight price protection, you'll start the day like everyone else: a floater.  If we open significantly up or down, we may lock depending on the reason for the shift.  If we open steady, and slowly push back to 101-16, we'll probably keep floating to see if we can squeeze anything out of lenders.  The much much much better idea would be to lock and fund the existing loans and then get on the phones with your databases and let them know how much you know about MBS and that they should be ready to refi in January or February and with the 120 approval time frame on AUS's, you can get their app in now! and they can float with you until it's time to pull the trigger!  Talk about lifetime clients...  Now that's what this blog is all about.