Market Outlook - BNP PARIBAS - Investment Services India

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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 www.GlobalMarkets.bnpparibas.com
Fannie Mae has not discussed the interpretation of not marking loans to market; nor has it provided delinquencies by coupon, as Freddie Mac did. Neither agency has amended its MBS prospectus yet to discuss FAS 166/167 as a risk scenario for prepayments as they had done with the Home Affordable programme (this is however not required). In our view, agencies are more likely to reserve their portfolios for acting as a backstop bid, rather than using them up for buyouts. Given the richness of the 15Y sector, we also like selling 15Y 5.5s vs 30Y 6s. Despite 15Y 5.5s cheapening vs 30Y 6s over the past couple of days, there continues to be value in the trade. In Chart 7, we compare prepayment changes from November to December for 2007 and 2008 FN 6s. The increases in prepayments were fairly similar for the vintages. The chart shows delinquencies by vintage for FG 6s as discussed in the FRE Q3 10Q (FN 6s should show similar relative trends between vintages, though overall delinquencies should be much higher). If buyouts due to mods were the primary cause, we should have seen 2007s increase more relative to 2008. Chart 7: Prepays vs Dlq 2007 2008 Dec FN 30Y 6s 27.7 28.9 Nov FN 30Y 6s 20.0 22.5 Chg 7.8 6.4 Dlq (Q3, FG 6s) 6.65% 3.66% Source: Bloomberg, Freddie Mac We think that more than one month of mortgage applications may have been fitted into December in an effort by banks to convert loans to agency MBS to save capital. The 2008 vintage has proved to be the most callable and, given the better availability of HARP now than in April, borrowers may have taken advantage of all time rate lows in early December. To the extent Janiary prepayments could surprise to the downside, and since the increases in December were primarily in 30Ys, 30Ys may benefit disproportionately from the declines in January. For instance, 2008 15Y 5.5s increased by 2 CPR, while 30Y 6s by 6.4 CPR. 2007 5Y 5.5s slowed marginally, but 30Y 6s picked up 7.8 CPR. Sergey Bondarchuk / Suvrat Prakash / Bulent Baygun / Anish Lohokare 29 January 2010 Market Mover, Non-Objective Research Section 33 www.GlobalMarkets.bnpparibas.com
Page 1 and 2: Market Economics | Interest Rate St
Page 3 and 4: GGBs and other peripherals will rem
Page 5 and 6: The subtle changes in the wording o
Page 7 and 8: US: Get It While You Can • As the
Page 9 and 10: 500,000, the months-supply level of
Page 11 and 12: France: Roaring Consumption • Ret
Page 13 and 14: should be particularly true for the
Page 15 and 16: UK Inflation: Bridging the Gap •
Page 17 and 18: eceive roughly 60/40 weight within
Page 19 and 20: 1.2% m/m in November, partly offset
Page 21 and 22: or absence of competitors in a spec
Page 23 and 24: Japan: Polarisation in Machine Tool
Page 25 and 26: Australia: The Next Step • Data r
Page 27 and 28: US: Post-FOMC Treasury Market Overv
Page 29 and 30: US: Rolling Down the Agency Spread
Page 31: US: Poor Housing Underscores MBS Su
Page 35 and 36: EUR: Timing the 20Y Point • The l
Page 37 and 38: EUR 3-5bn (new 10y) in February? Co
Page 39 and 40: JGBs: Supply Continues to Weigh •
Page 41 and 42: Table 1: BNP Paribas' Inflation For
Page 43 and 44: Table 3: BNP Paribas' Inflation For
Page 45 and 46: Pricing Date Repo Rate EUR DRI FRF
Page 47 and 48: CNY: Revaluation and FX Reserves
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Page 51 and 52: USD Bullish Signals • USD Trade W
Page 53 and 54: Currency Spot Trade Recommendations
Page 55 and 56: Economic Calendar: 29 Jan - 5 Feb (
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Page 63 and 64: Key Data Preview Chart 15: US Non-F
Page 65 and 66: Economic Calendar: 8 February - 5 M
Page 67 and 68: Next week's T-Bills Supply Date Cou
Page 69 and 70: Economic Forecasts GDP Year 2009 20
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