Market Outlook - BNP PARIBAS - Investment Services India

After the announcement concerning the GSEs in late
December, our outlook on spreads is much milder,
around 15-20 bps of widening. With the
announcement, agencies in total have about USD
100 bn in purchasing power for the year, and can act
as a backstop bid. But we underscore that our milder
outlook particularly hinges on the GSEs. As shown in
Chart 2, the spread to agency debt is fairly attractive
on a historical basis and a small widening could go a
long way in improving the economics further.
Past two H.8 reports have shown banks decreasing
their MBS portfolios (Chart 3: latest release covered
the week ending 13 January). As shown in Chart 4,
cash assets of banks have been highly correlated
with the level of excess reserves in the market. As
excess reserves reduced over the past few weeks,
bank cash reduced as well, initially.
Banks seemed to have then sold mortgages and
improved their cash position. While this trend is only
recent, there is a reasonable chance that banks do
not step in to buy mortgages in size unless they
cheapen materially. Banks are typically total
spread/USD price players rather than OAS, and buy
mortgages when they have a benign outlook on
volatility. But with vol (gamma) already so depressed,
they may be reluctant to buy mortgages (though the
mortgage exposure to vol has technically reduced
given the burnout seen in the refi index). The winding
down of liquidity programmes may cause excess
reserves to decline further.
Housing data released this week are indicative of the
need for the government to keep mortgage rates low.
Both existing and new home sales for December
came in well below market expectations. The Case-
Shiller Index was only slightly disappointing, but
covered November and not December, which should
be worse. As shown in Chart 5, despite the extension
of tax credits, the purchase index has not recovered.
If mortgage rates increase substantially, they may
hurt the typical housing market improvements due to
seasonality seen in spring.
Overall, with the attractive carry in the short term (for
higher coupons), and the necessity of government
support in the intermediate term, whether through the
Fed or GSEs, we continue to favour mortgages.
Since spreads are at the wider end, it also provides
investors with an attractive point to initiate new longs.
In terms of the coupon stack, we continue to like up
in coupon, particularly 6s. As shown in Chart 5, the
actual completion of loan mods remains quite low.
December prepayments may have been influenced
by faster completion of the origination and
securitisation process, with banks looking to
conserve capital, rather than a secular increase (see
Dec Prepay Commentary). We particularly like up in
Chart 4: Bank Cash Assets vs Excess Reserves
1400
1300
1200
1100
1000
900
800
700
600
500
Dec-08
Jan-09
Feb-09
Source: Bloomberg
Mar-09
Excess Reserves
Total Bank Cash
Apr-09
May-09
Jun-09
Chart 5: Purchase Index hasn’t Recovered
despite Extension of Homebuyer Credits. Refi
Index had Already Burnt Out
8000
7000
6000
5000
4000
3000
2000
1000
0
Feb-
09
Mar-
09
Apr-
09
Source: Bloomberg
Refi Index
May-
09
coupon as we near January prepayments, since
prepays may surprise to the downside for this
reason. We also think that the likelihood of FAS
166/167 having a measurable impact on
prepayments is quite low.
Jul-09
Aug-09
Purchase vs Refi Index
Jun-
09
Prch Index (rhs)
Jul-
09
Aug-
09
Sep-
09
Oct-
09
Sep-09
Nov-
09
Oct-09
Dec-
09
Nov-09
Jan-
10
Chart 6: Completion of Loan Mods Poor
HAMP Total (Dec 09)
Trial Plan Offers 1,164,507
# of Trial Mods started 902,620
Active mods 853,696
Active Trial Mods 787,231
Perm Mods Approved by Serv 112,521
(Perm Mods done 66,465
Perm Mods awaiting borrower acceptance) 46,056
Source: financialstability.gov
Dec-09
320
300
280
260
240
220
200
180
Sergey Bondarchuk / Suvrat Prakash / Bulent Baygun / Anish Lohokare 29 January 2010
Market Mover, Non-Objective Research Section
32
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