MBS MORNING: Not THAT Bad Considering...

By: • Wed, Feb 4 2009, 10:44 AM

Lots and lots to talk about today....

FN30_________________________ GN30______________________

FN 4.5 -------->>>> +0-01 to 100-18 GN 4.5 -------->>>> +0-01 to 100-24

FN 5.0 -------->>>> +0-00 to 101-19 GN 5.0 -------->>>> +0-00 to 101-28

FN 5.5 -------->>>> -0-01 to 102-08 GN 5.5 -------->>>> -0-01 to 102-14

FN 6.0 -------->>>> -0-01 to 102-31 GN 6.0 -------->>>> -0-02 to 102-27

After making advances on Monday, yesterday turned out to be another up and down day with reports of multiple intraday lender re-prices. Early in the morning MBS profit takers prevented the stack from gaining any momentum, however by early afternoon cheaper MBS prices attracted bargain buyers which restored some feeling of status quo.

If you haven't heard (note sarcasm) mortgage rates have risen a few bps over the past three weeks...there are several explanations that can be offered up to justify the increase in rates, the most widespread/accepted reason is that lenders are at operational overcapacity. So to allow for the appropriate accommodations to be made for "it that shall not be named" lenders slowed production via higher mortgage rates. Although originator MBS selling (you are not locking loans) has markedly slowed during this process it doesn't appear to be holding back borrowers from at least submitting new mortgage applications.

Here are few excerpts from the MBA Weekly Mortgage Applications Survey...

The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending January 30, 2009. The Market Composite Index, a measure of mortgage loan application volume, was 795.4, an increase of 8.6 percent on a seasonally adjusted basis from 732.1 one week earlier. The Refinance Index increased 15.8 percent to 3906.3 from 3373.9 the previous week

The four week moving average for the seasonally adjusted Market Index is down 9.2 percent. The four week moving average is down 4.7 percent for the seasonally adjusted Purchase Index, while this average is down 10.7 percent for the Refinance Index.

The refinance share of mortgage activity increased to 73.2 percent of total applications from 72.8 percent the previous week.

The average contract interest rate for 30-year fixed-rate mortgages increased to 5.28 percent from 5.22 percent, with points increasing to 1.12 from 1.05 (including the origination fee) for 80 percent loan-to-value (LTV) ratio loans.

Read the entire MBA Mortgage Application Survey by clicking HERE

Remember this report tracks the number of Americans applying for a mortgage. Not locks. Not closings. So while the application numbers are up...originator supply of MBS has been muted recent.... this leads us to believe that borrowers are preparing for "it that shall not be named" by getting their loans into lender processing systems ahead of the pack. (Not trying to sensationalize the prospects for a refi boom...we just believe it will happen eventually).

After the Fed announced its plan to support mortgage markets, the MBS current coupon (MBS trading closest to, but not above, 100-00) went "down in coupon" at a feverish pace until it settled below 4.00%. When the stack compressed (spread between prices of 4.0 MBS and 6.0 MBS tightened) in late December/early January and lenders didn't come through with their end of the deal, traders were then left in quite the predicament. The entire stack was trading at a premium (over 100-00) and prepayments were not as wide spread as expected. Do they wait to buy more 4.0s and 4.5s? How long will they have to wait? How risky would it be to buy "up in coupon"?

The resulting trade was a little of both which pushed the stack into a stagnant state.While day traders rode the wave of Fed spending lenders desperately tried to hedge their pipelines amidst multiplying fall outs. The MBS current coupon slowly started increasing from its below 4.00% levels. More recently the run up has felt increasingly cumbersome...lenders have been quick to re-price for the worse and slow to pass along gains. But I must say the recent run up of mortgage rates actually hasn't been as bad as could be....

President Obama is aggressively seeking a solution to our economic crisis. This resolution involves more government spending which of course means more government debt issuances to pay for the spending. Remember mortgage backed securities have a big brother that generally leads the MBS stack in one direction or another (not intraday). So when Treasury yields have risen this much...

...and MBS have remained somewhat stable... we remain positive. Considering all the challenges the Fixed Income environment is currently facing...we are actually thankful. If anything the sell off was a necessity, to align market expectations with originator offerings. Not to mention MBS buyers remain at the ready to move "down in coupon "on weakness which implies they too believe "it that shall not be named" will come eventually. This doesn't include lenders though...they are in their own world. My point is considering the recent steepening of the yield curve things aren't all that bad in MBS world.

Well this morning fixed income securities got a little more direction. The Treasury Department released the TBAC report which outlines just how much more the Federal Government needs to borrow to finance expenditures (how much supply of bills, notes, and bonds will be available). Here are a few quotes from the TBAC report...well more than a few but they are all important to gain some perspective....

"Policy efforts have begun to unlock credit for select high-quality borrowers. But the magnitude of wealth destruction, the still heightened cost of economy-wide capital and the impaired system of financial intermediation continue to cast a dark cloud over the economic outlook."

"the necessary deleveraging of both the financial and household sector is considerable and has further to run."

"the speed at which businesses are cutting headcount and reducing compensation is raising the risk of deflation. Given elevated debt levels, such an outcome would be extremely problematic for the financial sector and real economy."

"Tax receipts are declining at a brisk pace given the climb in unemployment, reduced wealth and slowing corporate profits. Receipts were down by nearly 10% in the first three months of the new fiscal year and the pace of decline appears to have accelerated in January."

"The recent steepening led by the rise in longer-dated yields, however, partly may be a by-product of the Treasury's outsized funding needs in 2009-2010. Further substantive increases in Treasury yields may prove counterproductive to policy actions already underway."

"The deterioration in the budget outlook, combined with expenditures associated with the TARP, potential FDIC guarantees, and expected additional stimulus spending have increased private forecasts for total funding needs of the U.S. government for fiscal year 2009 to approximately $2 trillion. This is likely to stress the existing auction schedule and consequently warrants tangible adjustments to that schedule."

"Furthermore, the Committee also stressed the importance of maintaining focus on the overall average maturity of the debt to ensure that financing is distributed across the maturity spectrum." (THIS RELATES TO MBS OP-ED: Q&A with the Readers)

"It was the Committee's recommendation that existing monthly 2-year and 3-year notes could be increased by $5 billion in size, to $45 billion and $35 billion, respectively."

"Furthermore, the Committee recommends that monthly 5-year notes have the greatest room for expansion given their liquidity and focus and should be increased by as much as $10 billion per issue. This would bring the monthly issuance size to as much as $40 billion."

"And lastly, the committee recommends that the Treasury increase the size of the newly issued quarterly 10-year notes by $5 billion and by $4 billion when re-opened the two months following the new issue. In other words, the sizes of the 10-year issuances would increase from $20 billion, $16 billion and $16 billion each quarter to $25 billion, $20 billion and $20 billion, respectively."

"Furthermore, the Committee recognized that the changes were not sufficient to meet its borrowing needs and that the Treasury must introduce new coupon issues to its calendar. While the number of new issues discussed by market participants, and the Committee, were a 4-year, 7-year, 20-year, and super-long (50-year) maturity issue. Among these choices, the Committee believes that a 7-year issue would be best accepted by the marketplace. Consequently, after much discussion, the committee recommends that the Treasury announce a new 7-year maturity issue monthly. The pattern and size of the issue is recommended to be $15 billion quarterly, with subsequent re-openings of $10 billion over the following two months."

"The average maturity of the debt has already fallen from a range of 60 to 70 months which existed from the mid 1980's until 2002 to a level of 48 months more recently." (THIS RELATES TO MBS OP-ED: Q&A with the Readers)

"There is near consensus that Treasury's funding needs during the next two years will be the largest in the post-war era in dollar terms, and likely also as a percent of GDP. The net supply of Treasurys in 2009 and 2010 combined seems likely to total more than $3 trillion and could climb as high as $4 trillion. The Congressional Budget Office (CBO) estimates the 2009 Federal budget deficit to be $1.2 trillion."

TBAC Report http://www.treas.gov/press/releases/tg10.htm

Quarterly Refundings http://www.treas.gov/press/releases/tg09.htm

OK SO CONSIDERING THE AMOUNT OF TSY SUPPLY THAT IS GOING TO HIT THE MARKETS. WE ARE HAPPY TO BE FLAT FOR NOW. Thank your lucky stars that the Fed is supporting the MBS market!!!