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MBS: Sell MBS for Cheap Vol • Mortgages OASs are tighter as MBS didn’t react fully to the spike in vol. Selling MBS versus rates (duration neutral) would be a cheap way to go long vol. We remain negative on mortgages with an expectation of overall rising risk premium. Payrolls could provide an attractive level to initiate new shorts. • We continue to like 15Y/30Y and GN/FN swaps. • Both GNMA and FRE delinquency data point to a relief. While the flight to quality (FTQ) continued to hurt mortgages, on a vol adjusted basis, mortgages have actually tightened, as they haven’t reacted as much to the sharp increase in vol. Chart 1 shows the recent Libor OAS history of FN 30Y 4.5s. In large vol moves, frequently, mortgages have tended not to react to the full extent. Chart 2 shows some days on which sharp increases in vol have caused OASs to tighten and sharp declines caused OASs to widen. With OASs at the tighter end, the discrepancy between vol and mortgages could correct over the next few days. In short, selling mortgages versus rates on a duration-neutral basis would be a cheap way to go long vol. Mortgages have traded to shorter durations and thus the current coupon rate has been kept reasonably in check, reducing convexity needs. Furthermore, one takeaway this week was that the market has rejected the 3.5% level on the 10Y Treasury. While investors may have used the rally to sell at higher dollar prices, believing in a range-bound environment, we are only a hairline away from the 3.5% level. We’re not certain that the 10Y can once again convincingly back away from the 3.5% level as it did on Wednesday, as selling in the next rally may be less pronounced. On the higher side, recall that the market had also rejected the 4% level on the 10Y Treasury during the previous auction cycle. So any break away from this range-bound environment may catch some investors off guard, and be supportive for vol. Despite their richening over the past week, we continue to favour 15Y/30Y swaps, particularly 15Y 4/30Y 4.5s as short mortgage basis and long vol expression. While 15s/30s are a steepener, we have seen bull flatteners in the context of FTQ flows, which have also caused an increase in vol, making this trade attractive in either rate direction. 25 20 15 10 5 0 Chart 1: Recent LOAS History of 4.5s 1-Mar 15-Mar 29-Mar 12-Apr 26-Apr Source: Yield Book Chart 2: FN 5% OAS Changes on Large Vol Moves OAS Chg Vega Chg Gamma Chg 5/4/10 -6 6 7 10/9/09 -6 4 11 7/2/09 5 -3 -10 6/9/09 9 -3 -7 6/1/09 -10 9 21 Source: BNP Paribas, Yield Book, Bloomberg 1300000 1200000 1100000 1000000 900000 800000 700000 600000 500000 Chart 3: Excess Reserves vs. Equities 1/1/09 2/1/09 3/1/09 4/1/09 5/1/09 6/1/09 7/1/09 8/1/09 9/1/09 10/1/09 11/1/09 12/1/09 1/1/10 2/1/10 3/1/10 4/1/10 5/1/10 Source: BNP Paribas Excess Reserves One theme we have frequently highlighted is the significant decline in risk premium that can likely be traced back to the Fed’s mortgage purchases. But as mortgage purchases have ceased, and excess reserves are on the decline, no new cash is being created that can chase assets on weakness. Chart 3 shows that equities have closely followed excess reserves with some lag in both directions. The significant correlation among risky asset classes seen in Charts 4 and 5 imply that if FTQ continues, mortgages and other risky asset classes could continue to suffer in tandem and reinforce the DJIA 12000 11000 10000 9000 8000 7000 6000 Anish Lohokare/Timi Ajibola 7 May 2010 Market Mover, Non-Objective Research Section 36 www.GlobalMarkets.bnpparibas.com
decline. We continue to maintain our underweight mortgage position with an expectation of an overall increase in risk premia. Payrolls, usually supportive mortgages, may present a good opportunity to initiate new mortgage shorts. As we highlighted last week, GNs haven’t benefited from the rally in Treasuries due to the FTQ, despite representing sovereign US credit, a theme echoed this week. But with Asia back from Golden Week, and as we close in on structure final date for CMOs, GN/FN swaps hold value. We prefer ‘current’ coupon rather than premium coupon swaps due to the spectre of TBW buyouts. That said, as discussed in the next subsection, GN delinquencies and CBRs are on a decline, with voluntary prepayments quite low, and thus beyond the TBW buyout possibility, premium GN/FN swaps also offer value. GNMA DLQ and CBRs decline The GNMA delinquency report for March (released with a one-month delay) showed a decline in 90+ day delinquencies across most issuers. For instance, BofA 90+ day delinquencies declined from 1.1 to 0.6%, Chase declined from 2.53 to 2.27, Citi declined from 1.25 to 1.13 and Wells declined from 0.27 to 0.23; total delinquencies declined from 2.1 to 1.9. With the exception of Chase where conditional buyout rates “CBRs” increased from 6.2 to 7.2, CBRs also declined for most top issuers. For instance, CBRs decreased for BofA from 16.1 to 10.5, for Citi from 7.6 to 8.3 and for Wells from 7.9 to 5.5. The delinquent numbers are based on remaining balance of pools each month after buyouts (Charts 7-9). A separate FHA report released at the end of April also showed that delinquencies declined from 9.17 in February to 8.76 in March. However, TBW delinquencies continue to creep higher and now stand at 18.50%. We had also highlighted GMAC as having the potential for increased buyouts due to their 90+ day approaching the 5% threshold. GMAC's 90+ day delinquencies increased from 4.93 to 5.00. The CBR increased for GMAC from 1.1 to 1.9, while it decreased for all GNMA issuers from 8.8 to 6.2. It seems like GMAC might just be buying out enough loans to keep in compliance with the GNMA requirement. FRE delinquencies decline as well Freddie Mac's aggregate 90+ day delinquencies fell for the first time in recent history, from 4.20% to 4.13%; both CE and non-CE loans reflected declines, particularly the former (9.12% to 8.87%). Note that, starting this month, FRE also retroactively added structured transaction delinquencies to the mix. The 90-119 and 120+ by coupon and vintages remaining in pools also reflected declines. The retained portfolio increased to USD 753.3bn from USD 732.2bn, 12000 11000 10000 9000 8000 7000 6000 Dec-08 Jan-09 Source: BNP Paribas 210 190 170 150 130 110 90 70 50 4/1/2009 5/1/2009 Chart 4: Equities vs. ABX DJIA ABX-HE 06-1 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Chart 5: Corp Spreads vs. Oil 6/1/2009 Source: BNP Paribas AAA 5Y Corp CDS 7/1/2009 8/1/2009 9/1/2009 10/1/2009 Crude Oil Px (rhs, reverse axis) 11/1/2009 12/1/2009 1/1/2010 2/1/2010 3/1/2010 4/1/2010 5/1/2010 Chart 6: GN vs. FN Premium Prepays Total CPRs GN 6 Mar FN 6 Est* GN 6.5 Mar FN 6.5 Est* 2009 24 23 26 23 2008 27 35 27 37 2007 26 32 24 40 2006 24 33 22 35 2005 19 27 19 32 Voluntary CPRs GN 6 Mar FN 6 Est* GN 6.5 Mar FN 6.5 Est* 2009 15 18 15 23 2008 16 27 14 25 2007 14 23 11 22 2006 15 23 12 21 2005 9 14 6 16 Source: BNP Paribas * Post buyout terminal speeds reflecting a USD 51bn increase in whole loans with agency MBS declining USD 28.5bn. Both numbers mainly reflected FRE buyouts and the latter also some FNM buyouts. Note that the portfolio size is capped at USD 810bn at the end of 2010 (Charts 10, 11, 12 and 13). Positive housing seasonals and particularly the boost before the housing tax credit expiry in April, may have contributed to decline in delinquencies. 95 90 85 80 75 70 65 60 55 40 45 50 55 60 65 70 75 80 85 90 Anish Lohokare/Timi Ajibola 7 May 2010 Market Mover, Non-Objective Research Section 37 www.GlobalMarkets.bnpparibas.com
Page 1 and 2: Market Economics | Interest Rate St
Page 3 and 4: UK: all eyes on the election US: re
Page 5 and 6: Event response The ECB is being ove
Page 7 and 8: Eurozone Periphery: Compare and Con
Page 9 and 10: over 20% in Q1) and, last but not l
Page 11 and 12: Market Stress Charts • Signs of s
Page 13 and 14: Chart 7: Greek Bank CDS* 900 Greece
Page 15 and 16: • The plan also contains a number
Page 17 and 18: Germany: Downs and Ups • The impa
Page 19 and 20: Retail sales data from month to mon
Page 21 and 22: On inflation, the statement was als
Page 23 and 24: quarterly average of 2.7% in the fi
Page 25 and 26: US Credit: Still the Recovery’s B
Page 27 and 28: Japan: Rising Chance of Sales Tax H
Page 29 and 30: BNP Paribas Surprise Indicator •
Page 31 and 32: UK headline After surprising to the
Page 33 and 34: US: Supply Could Affect Swap Spread
Page 35: steep curve is typically associated
Page 39 and 40: Chart 12: 90-119 Day Dlq for FRE 90
Page 41 and 42: the gamma sector for some time now.
Page 43 and 44: EUR: Limited Nervousness at ECB Ten
Page 45 and 46: with the big redemption (EUR 17.7bn
Page 47 and 48: measures are not promptly taken to
Page 49 and 50: Table 1: BNP Paribas' Inflation For
Page 51 and 52: Table 3: BNP Paribas' Inflation For
Page 53 and 54: Table 1: BNP Paribas Carry Analysis
Page 55 and 56: What’s the call? It is relatively
Page 57 and 58: Update on FIN SEN and FIN SUB 5/10y
Page 59 and 60: Germany 10y: Within MT falling wedg
Page 61 and 62: Judging Currencies by Liquidity •
Page 63 and 64: type of regulation would reduce mon
Page 65 and 66: Euro Dives • The euro is collapsi
Page 67 and 68: Currency Spot Trade Recommendations
Page 69 and 70: Economic Calendar: 7 - 14 May (cont
Page 71 and 72: Key Data Preview Chart 1: US Payrol
Page 73 and 74: Key Data Preview Chart 5: UK Manufa
Page 75 and 76: Key Data Preview Chart 9: French GD
Page 77 and 78: Key Data Preview Chart 13: US Indus
Page 79 and 80: Treasury and SAS Issuance Calendar
Page 81 and 82: Central Bank Watch Interest Rate EU
Page 83 and 84: FX Forecasts* USD Bloc Q2 '10 Q3 '1
Page 85: RESEARCH DISCLAIMERS: IMPORTANT DIS

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