Bank traders are hoping to profit from what they believe will be a repricing of non-agency mortgage backed securities, believing that a discount caused by the sub-prime fallout is about to be reversed.
Highly-rated non-agency mortgage bonds, issued by banks such as Citi and Wells Fargo, have historically traded in line with their agency counterparts because the quality of the loans is similar.
However, the fallout from the sub-prime mortgage market, where borrowers are defaulting on their payments, has led investors to be more risk-averse. Agency mortgage backed securities have been more appealing because they carry a guarantee of the timely payment of interest and principal. This has caused non-agency loans to trade at a discount.
Laurie Goodman, head of the US securitised products strategy group at UBS in New York said: "Non-agency loans have cheapened dramatically. Our number one trade in the mortgage market right now is to buy super-senior triple-A non-agency securities."
Spreads have remained wide over the past four weeks but mortgage market specialists believe they will narrow, especially as supply will be diminished because fewer new loans are being extended.
"Once this overhang of non-agency paper is cleared up there is nothing behind it. Anything in Alt-A that can go through agency execution, which we estimate is about half the market, will do so. Non-agency super senior mortgage paper without a credit dimension is extremely attractive," said Goodman.
Non-agency bonds have steadily been trading more cheaply since problems in the sub-prime market first emerged in the spring. At the end of March, jumbo Alt-A mortgage bonds with a 6% coupon, which are derived from loans made to borrowers who are typically one notch above sub-prime status, were trading at a price of 32 basis points below comparable agency securities issued by Fannie Mae. By August the discount had widened to 112 basis points, according to data from Deutsche Bank.
Similarly, the discount on prime jumbo mortgage bonds, which are based on loans extended to borrowers with high credit scores, widened from 21 basis points at the end of March to 60 basis points.
In 2005 issuance of non-agency mortgage securities overtook agency issuance for the first time, accounting for 55% of the total.
In July non-agency mortgage backed security issuance accounted for 35.6% of total issuance, with the remaining 64.4% in agency deals, according to UBS.
James Grundy, as associate at Standard & Poor's residential mortgage backed securities group, said: "We expect loan quality to improve over time as the effects of tightened underwriting guidelines make their way through the securisation pipeline."
Source: efinancialnews.com
Interesting post on mortgages.
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