Mortgage Backed Securities Weekly 18 November

Albert Durso, Senior Market Analyst - MBS Sally A. Runyan, CFA, Senior Market Analyst - MBS
M Professional Media-USA-TTD
Albert.Durso@thomsonreuters.com Sallyann.Runyan@thomsonreuters.com

Friday November 15, 2013

Other Items of Interest: Monday: FRB New York President Dudley (12:15), FRB Philadelphia President Plosser (13:30), FRB Minneapolis President Kocherlakota (19:45) Tuesday: FRB Chicago President Evans (14:15), Chairman Bernanke (19:00) Wednesday: FRB NY President Dudley (10:00), FRB St. Louis President Bullard (12:10), FOMC Minutes (14:00) Thursday: FRB Governor Powell (9:45), Treasury announces 2-, 5- and 7-year notes (11:00), FRB Richmond President Lacker (12:30), 10yr TIPS auction (13:00), FRB St. Louis President Bullard (13:00), Fed MBS purchases report (14:00) Friday: FRB Kansas City President George (8:40), FRB Governor Tarullo (12:15)

Key Points: 48-hour day for Class C is Tuesday, Nov. 19 and Friday, Nov. 22 for Class D. Economic Releases: Monday: NAHB HMI (Nov) Tuesday: ECI (Q3) Wednesday: MBA Mortgage Application Indexes, CPI (Oct), Retail Sales (Oct), Business Inventories (Sep), Existing Home Sales (Oct) Thursday: PPI (Oct), Philly Fed (Nov), Initial Claims, FHLMC PMMS

Don't forget to visit www.ifrmarkets.com for real time analysis and commentary during the trading day.

The Week Ahead The pattern may have been set and the dye already cast after the correction and consolidation post-payrolls, as we appear to be on semi-auto pilot with respect to any moves heading into the Thanksgiving holidays. Unless the next payrolls report prints as robustly as the last release, then the market will drift a bit until risk events present themselves. FOMC minutes this week may have a moderate impact on future QE3 timetables; however, the market seems to have found its interim level. Certainly thinned supply has tilted the bias toward tightening unless and until any unforeseen risk events occur. Lower shorter-term funding rates for a longer period of time seem to be the template, and that will inspire and elicit more MBS carry trades as rolls remain elevated. The lower stack wont decompress or compress much more this week as lower FN3.5/3 swaps remain just above four points, while rate-sheet sensitive FN4/3.5s remain 1/4 point above three points. For 15yrs, their fast run-up post-NFP seems to have backtracked slightly with current levels seen as support; although as curve predicated as they are, we dont portend a flattening of the yield curve. No real moves are expected away from two points and 7/8 of one point on the Current Swap (DW3/FN3.5) and Bottom Swap (DW3.5/FN4). The same goes for GNMAs and GNMA IIs versus longer FNMAs which seem comfortably mired in a short-term range with corrections and adjustments priced in.

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For the 30yr FNMA Current Coupon basis, the familiar range corridor is set: +60/10yr notes and +65/10yrs as supply is seemingly no match for demand, given a lessened event risk backdrop. The Week That Was The holiday-shortened week began with taper trepidation following the better than expected employment report and ended more confident again that the FOMC would likely not begin until March 2014. The improved confidence stemmed from Janet Yellen's testimony on Thursday before the Senate Banking Committee in regards to her nomination for Fed Chairman, which markets interpreted as dovish in regards to monetary policy. In her prepared remarks, she noted that the current unemployment rate of 7.3 percent while down from a peak of 10 percent "is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time." She went on to say the Fed's use of its monetary policy tools was "to promote a more robust recovery", adding "I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy." During the Q&A portion of her testimony, her responses related to QE were that (1) it has made a meaningful contribution to the recovery; (2) there was no set time for when they would decide to slow their pace of buying and that it was a meeting by meeting assessment of conditions; and (3) at this time she believed the benefits have exceeded the costs. Markets rallied on her testimony with the 10-year note yield declining to 2.725 percent on Thursday after rising to 2.768 percent on Tuesday on further fallout from nonfarm payrolls. Meanwhile, economic news was mixed at best which did not aid investors in any fine tuning of taper odds; however, next week has a fuller calendar of data including Retail Sales, Philly Fed, inflation, Existing Home Sales and NAHB. In Structured Products Research from Wells Fargo, analysts noted that if the data leading up to the jobs report at least does not disappoint while NFP is another positive report, markets are likely to price in a "sooner" taper and push rates significantly higher. Markets also may be especially sensitive based on what is revealed in the minutes from the FOMC's October meeting which is released on Wednesday afternoon. While MBS investors are attuned to the taper potential, they remained cognizant as well of the strong technicals currently in the sector because of the Fed's presence. This kept the 30-year current coupon spread tightly range bound at between +66.2 and +62/10yr note over Tuesday through Friday, and investors opportunistic to weakness and strength across the coupon stack (see graph above).

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Until there is more key data or other information to gauge taper timing, the supply/Fed-demand dynamic should keep spreads in a tight range with investors trading on intraday richening or cheapening. While lower coupons especially benefited on Yellen, even before that flows were moving down in coupon following recent gains brought on by (1) the employment related sell-off that led flows up in coupon; (2) the rate sensitivity and burnout that is showing in higher coupon prepayments, and (3) the blocked nomination of Rep. Mel Watt for FHFA Director. With flows essentially two-way among private investors, the Fed was left to absorb the mediocre supply from originators that averaged just $1.3 billion per day while its appetite on net equated to $2.8 billion per day based on its latest weekly purchases report. Buying was focused on 30-year 4s and 3.5s which is where the majority of supply is at. Selling from mortgage bankers is expected to remain limited at current mortgage rate levels as only a modest percent of organic borrowers have an attractive enough incentive. The latest reports from the Mortgage Bankers Association and Freddie Mac indicated effective 30-year fixed conforming rates at about 4.50 percent, while refinancing activity declined further according to the MBA. In order to really stimulate refinancing activity and thus supply, mortgage rates have to decline well through 4.0 percent. In other mortgage-related activity, 15s lagged 30s as the latter benefited the most on the dovish Fed outlook, while GN/FNs held firm on favorable technicals. Trading in specified pools was mixed with bid lists from originators, as well as, real and fast money particularly weighing on the sector (and payups) early in the week. For the week, volume was near average at 92 percent of the 30-day moving average versus 113 percent previously; the 30year current coupon spread was over 4 basis points tighter to +62/10yr note, while 3m10yr vol was down about 8 basis points. Meanwhile, excess return to Treasuries on Barclays MBS Index for the week through Thursday was +15 basis points. Headlines from Week of November 11 Regulatory/Legislative The Senate Banking Committee could vote on Janet Yellen's nomination for Fed Chairman as soon as the week of Nov. 18. (http://www.reuters.com/article/2013/11/14/us-usa-fed-yellen-committee-idUSBRE9AD17F20131114). The NYFRB reported gross agency MBS purchases of $14 billion and net purchases of $11.2 billion in the holidayshortened week ending November 13. Net buying averaged out to $2.8 billion per day which compared favorably to mortgage banker selling that averaged $1.3 billion per day. Other items of interest are highlighted below. o The Fed engaged in dollar rolls totaling $2.8 billion; 78.6 percent were in 30-year 4.5s (13.6% FH, 86.4% FN) and 21.4 percent in Dwarf 3.5s. o Buying in 30-year 4s increased to 42.0 percent of total purchases from 30.1 percent as the Fed followed supply; 3.5s declined to 48.2 percent from 59.9. o GNMA purchases declined to 17.9 percent from its more normal average of 20 percent, while 15s held just below 10 percent at 9.8 percent.

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Coupon 30yr 2.5% 3.0% 3.5% 4.0% 4.5% 15s Weekly Total Cumulative Total

FHLMC Amount Percent 2,700 88.5% 0 0.0% 0 0.0% 1,450 53.7% 1,250 46.3% 0 0.0% 350 11.5% 3,050 27.23%

Fed MBS Purchases FNMA GNMA Amount Percent Amount Percent 5,400 87.8% 2,000 100.0% 0 0.0% 0 0.0% 0 0.0% 0 0.0% 2,350 43.5% 1,600 80.0% 3,050 56.5% 400 20.0% 0 0.0% 0 0.0% 750 12.2% 0 0.0% 6,150 54.91% 2,000 17.86%

Total Amount Percent 10,100 90.2% 0 0.0% 0 0.0% 5,400 53.5% 4,700 46.5% 0 0.0% 1,100 9.8% 11,200 100.0%

Cumulative Total Amount Percent 1,067,850 84.3% 9,900 0.8% 481,300 38.0% 377,750 29.8% 186,150 14.7% 12,750 1.0% 198,850 15.7% 1,266,700 100.0%

Total since October 2011 345,600 27.3% 660,300 52.1% 260,800 20.6% 1,266,700 100.0%

The NYFRB said it expected to purchase $15 billion in agency MBS over the period beginning 11/14 to 12/11. This was in line with expectations and unchanged from the previous four week period. Along with $40 billion in outright purchases, Fed buying will remain at $55 billion, or about $2.75 billion per day, which is well above the $1.0 to $1.5 billion in mortgage banker supply currently. Housing-Related Headlines Freddie Mac reported a 19 basis points jump in the average 30-year fixed rate mortgage rate to 4.35 percent in the week ending Nov. 14. With an average 0.7 point, the no point rate is placed at about 4.53% percent which removes some borrowers underlying 4s from the refi window. This is the highest mortgage rates have been since the midSeptember FOMC meeting when the Committee decided against tapering, and should lead to a further reduction in refinancing activity in the next report from the Mortgage Bankers Association. o In order to increase the Refi Index to 3000, Nomura calculated the primary mortgage market survey rate would need to decline to between 3.875 and 4 percent. And in order for the index to move into the 5000 area reached when mortgage rates were in the low 3.30s, they said rates would have to drop to between 3.0 and 3.125 percent. None of this seems likely with Fed tapering on the foreseeable horizon.

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15-year fixed and 5/1 hybrid ARM rates experienced more moderate gains at eight and five basis points, respectively, to 3.35 and 3.01 percent. Meanwhile, one-year ARM rates were unchanged at 2.61 percent. RealtyTrac reported foreclosure filings on 133,919 U.S. properties in October, or 1 in every 928 housing units. This was up two percent from September, but down 28 percent from a year ago. The backlog of delayed judicial foreclosures continues to make its way through the pipeline, with many of these properties now being scheduled for the public auction after starting the foreclosure process last year or earlier this year, said Daren Blomquist, vice president at RealtyTrac. Freddie Mac released its Q3 Cash-Out Refinance and Product Transition Reports last week, and given rate levels, tight credit, and still recovering housing market, results were little changed from recent quarters and along expectations for the current conditions. For those who refinanced, 83 percent kept the same loan amount, 15 percent increased their loan balance by 5 percent or more, while 2 percent lowered their loan. These were all little changed from the previous two quarters. At the peak of the housing market in Q2 and Q3 of 2006, cash-out refinancings represented 89 percent of refinancings, while refis that resulted in no change in loan amount were at 10 percent. o The median appreciation of the property refinanced was -9 percent. Since Q3 2012, the median appreciation has been between -8 and -9 percent. The median age of the refinanced loan was 6.7 years from 6- to 4.9-years, respectively, from Q2 2013 back to Q3 2012. Freddie said this was the highest median age since the analysis began in 1985. Meanwhile, borrowers reduced their rate by an average of 30 percent from the old rate. Borrower rate reductions in Q2 and Q1 averaged 34 and 35 percent as mortgage rates were lower. In 2006, the median appreciation of the refinanced property was 34 percent and the age was just over 3-years. o Of those who refinanced in the third quarter, 37 percent shortened their loan term, up 5 percent from Q2, and the highest since 1992. Freddie also said that 40 percent of those who refinanced outside of HARP reduced their term and 32 percent of HARP borrowers did. The GSE's chief economist, Frank Nothaft, noted that "Mortgage rates on 15-year fixed-rate loans averaged nearly a full percentage point below 30-year loans during the third quarter, providing a financial incentive for homeowners to term shorten. HARP refinancers have an additional incentive to shorten as some origination fees are waived." o Nothaft added that "By obtaining lower interest rates, borrowers will save approximately $6 billion in interest over the next 12 months, which they can put towards savings, paying down debt or supporting additional expenditures." He also pointed out that an estimated $6.4 billion in cashed-out equity would "further augment borrowers' investment and consumption spending." This is well below what borrowers had to "augment" their lives in 2006 which reached $84 billion. o Fixed rate loans remained the most popular with over 95 percent of borrowers choosing one. Mortgage application activity declined 1.8 percent in the week ending November 8 from an upwardly revised -2.8 percent, previously reported as -7 percent, as mortgage rates increased further after a stronger than expected employment report. According to the Mortgage Bankers Association's weekly survey, the Refi Index fell 2.3 percent to 2076 from an upgraded 2125 in the prior week. The MBA originally reported refinancing activity had declined nearly 8 percent to 2076 for the week ending November 1. As a percent of total

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application activity, refinancing share held at 66 percent. o Meanwhile, the Purchase Index was essentially flat at 182.2 from 183.2 previously. Purchase activity was also revised upward in the last report to -0.7 percent from an originally reported -5.2 percent. Still, purchase activity remains well off its average of 211 to 215 between April and June of this year despite historically attractive rate levels and affordability. Tight credit conditions are inhibiting purchase activity and Bank of America Merrill Lynch MBS analysts expected credit availability would tighten further beginning in January with the rollout of QM and loan officer compensation rules. Affordability will also be impacted by continued home price growth amidst rising mortgage rates which will impact purchase activity ahead. o The average contract interest rate for 30-year fixed rate conforming loans jumped 12 basis points to 4.44 percent; FHA rates increased nine basis points to 4.16 percent. The MBA's Mortgage Credit Availability Index indicated slight easing in credit conditions in October. The index rose 0.7 percent to 111.5 after declines in August and September. Contributing to the easing, they said, was reduction in minimum credit scores on certain products by some investors. It was partially offset, however, by a slight reduction in the availability of cash-out refis and programs that allowed for second and investor homes. Other Domestic and International Headlines Moody's cut by one notch the long-term senior debt ratings of Goldman Sachs (Baa1), JPMorgan (A3), and Morgan Stanley (Baa2) citing it would be less likely for the government to bailout the institutions if they got into financial trouble. The euro zone expanded just 0.1 percent in the third quarter, or 0.4 percent annualized, compared to an annualize rate of +1.2 percent in the second quarter. Total Mortgage Related Issuance
Agency MBS Issuance (in blns) Freddie Mac $384.3 (27.4%) $422.8 (26.4%) $274.4(25.9%) $360.1(28.4%) $459.3 (27.7%) $316.1 (29.6%) $352.6 (35.8%) $360.0 (39.5%) $397.9 (41.2%)

Year 2013 (YTD) 2012 2011 2010 2009 2008 2007 2006 2005

Fannie Mae $669.5 (47.8%) $801.8 (50.0%) $519.7(49.1%) $562.4 (44.4%) $767.5 (46.3%) $493.8 (46.3%) $542.3 (55.1%) $481.9 (52.8%) $481.3 (49.8%)

Ginnie Mae $347.9 (24.7%) $379.0 (23.6%) $264.2(25.0%) $343.4(27.1%) $431.7 (26.0%) $256.5 (24.1%) $89.1 (9.1%) $70.6 (7.7%) $86.9 (9.0%)

Total Agency MBS $1,401.7 $1,603.6 $1,058.3 $1,265.9 $1,658.5 $1,066.4 $984.0 $912.5 $966.1

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Year 2013 (YTD) 2012 2011 2010 2009 2008 2007 2006 2005

Total Mortgage Related Issuance (in blns) Private-Label Agency Private Label Agency MBS Agency CMOs CMBS CMBS RMBS $1,401.7 $181.5 $62.5 $52.8 $7.2 $1,603.6 $285.1 $47.0 $45.8 $4.4 $1,058.3 $513.7 $35.1 $30.0 $2.8 $1,265.9 $477.15 $24.2 $21.6 $31.6 $1,658.5 $211.8 $5.1 $9.2 $21.5 $1,066.4 $246.5 $16.0 $3.7 $45.0 $984.0 $323.6 $231.4 $2.9 $655.6 $912.5 $317.0 $197.7 $7.5 $773.1 $966.1 $354.9 $164.2 $4.6 $645.3 Sources: eMBS, SIFMA, Thomson Reuters

Total $1,705.6 $1,985.9 $1,639.9 $1,820.4 $1,906.1 $1,377.6 $1,847.4 $2,207.8 $2,135.1

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