 |
| Art Frank |
Frank is a director and head of mortgage-backed securities research at Nomura in New York. What has been the impact of the disappointing employment data on the mortgage-backed securities market?
There has been a major repricing in the mortgage market since the jobs report came out. The premiums had been high before that. They have been very rich. The 6s in particular have been a very rich component and that is rather dramatically repriced now. They have underperformed the 5s. This happened on the morning of the jobs report release and the following Monday. There has been a re-pricing of 6s and in general mortgages have widened but not enormously. Much of the widening happened on Friday itself. Another widening happened on the following Tuesday. Since then, the mortgages have been trading close to the Treasuries.
Do you see the market widening in the coming weeks as refinancings pick up?
We have seen the reactions in premiums, which cheapened up substantially. Even given the differences in hedge ratios, the 6s have underperformed the 5s. It went up substantially prior to the employment data. The mortgage market is fairly pricing prepayment risk. Premiums haven't gotten ridiculously cheap. The refinance index will give us [last week's] number. We haven't seen significant increase yet. We expect to it to be above 4,000 next week. It will be a significant increase. But, the market has discounted that. If one looks at the interest-only scrips, the premiums have fallen and so I would say the market has already reacted appropriately to the prospect of prepayment risk.
Should Fannie Mae's steep losses in derivatives concern the market?
The markets reacted to a recent report by widening a couple of basis points and then came back. Fannie Mae and Freddie Mac have extensive derivatives transactions to hedge in their portfolios. They are like an extensive hedge fund. I do not see any serious trading losses. Periodically, government-sponsored entity stories affect the market. Fannie Mae's efforts to reduce the duration gap did concern the market last year. I am not convinced that there is any problem there. The debate in Washington about regulation is of concern to the equity investor, not the bondholders. The MBS investor is not really concerned about regulation.
What goes into your evaluation of MBS?
We make assumptions about interest rates and interest rate expectations on the Treasury curve, we take into account the swap curve, the agency debenture curve and the implied volatility of those rates as measured by swaps and volatility. These are the basic valuations that go into mortgage valuation. We also keep an eye on the spread between implied rate volatility and agency debentures.
Is your research qualitatively different from the rest in the industry?
The fixed-income market is largely an institutional market and so the concerns of equity research do not affect the fixed-income investors. There are no fundamental differences in the research methodology but there are differences in the details. The devil is in the details. The differences are in how one develops models. What the exact interest rate model is, how one takes into account key variables such as prepayment risk, refinances and turnover. There are only moderate to significant differences in how one treats these variables.
More importantly, firms have different product focus. We at Nomura come out with a monthly report on the Federal Housing Authority-Veterans Administration re-performing market because we are major dealers in the product. Some firms are less involved in this product. Some are more involved in adjustable-rate mortgages and so will devote more time and energy on ARMs.
Do you have any special preferences or favorites?
The relative value of mortgage-backed securities changes every day. It presently looks fairly valued versus other competing sectors. It is neither rich nor cheap. Our overall outlook is neutral for mortgages relative to the Lehman Brothers Aggregate Bond Index. Within the mortgage market, premium GNMAs are better than premium Freddie Mac and Fannie Maes. In 6s and 6 1/2s, we like specified pools, we like New York pools and loan balanced paper. We also see good opportunity in the non-agency market.