Market Mover - BNP PARIBAS - Investment Services India

US: Impact of Buyouts on Rates and MBS
• The GSE buyout announcements are
bearish for mortgages, as they could shrink the
potential base of investors post MBSPP end,
erode carry in the interim and potentially
remove GSEs as a backstop bid.
• We like being long the 5Y swap spread on
concerns around mortgage selling and a
possible flight to quality into Treasuries.
• The added uncertainty around the
conclusion of MBSPP is likely to provide a bid
to vol. We like being long gamma vol on 5y and
10y tails.
With GSE portfolios dedicated to buyouts, the
possibility of them being a backstop bid after the Fed
stops buying has diminished considerably. Money
managers are likely to be the only major buyer of
MBS, but would be hurt by the diminished liquidity in
the mortgage market and unable to stem an overall
increase in risk premia. As we have discussed
previously, banks are unlikely to support mortgages
in size. Overseas investors, already hurt by
capricious GN prepayments (only 16% of the market)
would be unlikely to support mortgages. We now look
for a 30+bp widening in mortgages, and with the
carry (in FGs) until Fed exit essentially lost, we've
turned negative on mortgages. Also, with the Fed
mostly in lower coupon fixed and other investors in
higher coupons and ARMs, the private market is
primarily taking the losses – and those too, quite
suddenly.
For FGs, with 30Y pools trading on the basis of Feb
prepays, with large negative carry and TBAs for
March settle, the market is likely to trade with
difficulty. With the ratio of ARM to Fixed
delinquencies at 5 times (12.54% vs 2.46%), the
price depreciation is likely to impact this market
particularly negatively. The CMO market also faces
difficulty given the price depreciation in Inverse IOs
due both to the type of collateral and leverage to
prepays.
For FNs, it is difficult to price TBAs, given the
variable term of buyouts and also since the
deliverability option is considerable. For example, at
80 CPR, the carry on FN 6s is -13 ticks, at 90 CPR
-27 ticks, at 99 CPR -79 ticks. Furthermore, very little
information is available on products other than 30Ys.
Since FN delinquencies for credit enhanced collateral
are about 70% higher than FGs, market such as
Chart 1: Mortgage Current Coupon LIBOR OAS
vs the 5Y Swap Spread
100
80
60
40
20
0
-20
-40
Mortgage Current Coupon LIBOR OAS
5y Swap Spread (RHS)
-60
0
Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10
Source: BNP Paribas, Yield Book
230
210
190
170
150
130
110
90
Chart 2: Gamma Over Time
70
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10
Source: BNP Paribas
3m10y ATM vol
10 yr swap (RHS)
140
120
100
ARMs could be even more hurt in FNs, given their
relatively higher delinquencies. Dealers, who are in
the business of carrying inventories in mortgage
products, are likely to be hurt considerably at the
beginning of the year. This bodes poorly for liquidity,
especially with the Fed exit around the corner.
As we have argued previously, it has always been
economical to buy out loans in the beginning, rather
than waiting until 24 month dlq for higher coupons
(5.5% and above). While FAS 166/167 improves the
economics for such loans, the principle of it being
economical for such bonds remains. The economics
argument offered by the agencies in yesterday's
announcements could be challenged.
Given the potential negative impact, we place a
decent probability of such factors being considered in
the actual implementation of the buyout
announcement, and amendments more favourable to
investors or a rolling back of these policies cannot be
ruled out. Regardless, the absence of the role of the
GSEs being a backstop bid from the
administration/regulator/government's point of view
bodes poorly for the basis.
80
60
40
20
4.5
4
3.5
3
2.5
2
Anish Lohokare / Bulent Baygun 12 February 2010
Market Mover, Non-Objective Research Section
18
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