Bond prices have backed up sharply over the last week.  The price of the 10-year Treasury note has lost almost 3 points since last Monday (10/3), pushing its yield from a low of 1.76% to around 2.17% on Tuesday (10/11) morning.  The driving factors are a modest recovery in stock prices (the DJIA has risen almost 7.5% since last week), relief from a decent jobs report, and a sense that the EU may agree to aid for Greece.  The comments by Peter Dixon of Commerzbank AG in London, quoted on Bloomberg, put it succinctly:  “Continuing funding to Greece is the least worst option available.  We should be thankful that sanity is prevailing, at least for now.”

MBS:  Weak and Erratic Performance

MBS have drifted wider since the Fed’s “Twist” announcement in September.  The announcement that they would be reinvesting principal and interest payments in new MBS caused a immediate sharp tightening of the current coupon spread versus Treasuries.  Since late September, however, MBS spreads (measured by the spread of the 30-year current coupon over interpolated Treasuries) have drifted wider.  In my mind, the tepid performance is due to a few different factors:

• High dollar prices.  The lowest liquid 30-year coupon is 3.5s, and Fannie 3.5s have been trading in the 103s since the Twist announcement.
   
• High realized volatility.  Even though option markets have remained pretty steady, the big jumps in bond prices and rates have scared off MBS investors.
   
• Lack of CMO demand for MBS collateral.  Creating and marketing agency CMO deals has been a challenge.  Demand for IOs has been sketchy, which makes creating bonds for banks difficult; the flatter curve has also make issuance difficult.

The MBS market has also had to keep an eye on refi risk.  The MBA refi index has recently posted some impressive numbers; the 4-week moving average of 3858 is at its highest level since last fall.  Markets also continued to be roiled by recurring rumors of a government-sponsored refi program.  While the proposals have varied over time, the notion is that homeowners whose loans are securitized in agency pools should be allowed to refi even if they have negative equity in their homes.  While this is viewed in many quarters as a “slam-dunk stimulus,” it is opposed by the acting head of the FHFA.  While the rumor mill has quieted down, the possibility of such a program arguably puts some pressure on the MBS market which, it should be noted, is trading at historic premiums over par value.

September Prepayment Report:  Picking the Low-Hanging Fruit

The prepayment report for September shows a big boost in speeds for newer-vintage “moderate premiums.”  2009- and 2010-product Fannie 4s (which have gross WACs in the 4.5% area) had their one-month CPRs more than double over August’s speeds; moderately-seasoned 4.5s (~5% WAC) experienced speeds between 27 CPR and 34 CPR, fast speeds in the current environment.  The chart below shows CPRs for liquid vintages of 30-year Fannie coupons.  What it suggests is that originators are picking the “low-hanging fruit” of relatively new loans with note rates between 4.5-5%; these borrowers have both decent credit and, for loans issued originated in or after 2008, sufficient equity.

Borrower Notes:  Refinance Into Shorter-Term Loans to Build Equity Faster

While consumer mortgage rates have ticked higher, they still approach historic lows.  Homeowners still carrying relatively high rates (i.e., anything in the area of 4.75% and higher) should consider trying to build equity faster by shortening their loan terms.  For example, a borrower with a 5% 30-year loan for $250,000 has a P&I payment of around $1340.  While refinancing into a 15-year loan at current rates would increase their monthly payment by more than $400, a 20-year loan might be a better option; depending on the rate that can be found, the monthly payment would increase between $125 and $150.  If borrowers look at this as a form of forced savings plan, it makes some sense, and should be considered.  (Note that 20-year loans are less commonly offered than those with 15-year terms, so shopping around is important.) 

Bill Berliner, Banc of Manhattan Capital - Profile
Banc of Manhattan Capital is an affiliate of Bank of Manhattan N.A. None of the information herein was prepared by or has been endorsed by Bank of Manhattan and does not constitute a solicitation for bank services. Banc of Manhattan Capital is a registered FINRA member Broker Dealer. This material was produced by a Banc of Manhattan Capital strategist and does not constitute investment research. It is neither an offer nor a solicitation to buy or sell securities. Any statements herein should not be construed as advice regarding individuals’ housing investments or mortgage debt. Information upon which this material is based was obtained from sources believed to be reliable, but has not been verified.