Friday, December 27, 2013

FLASH UPDATE: Initial MBS impact on Rep. Watt's decision to delay "g-fee" hike is muted

On Friday Dec 20th  Rep. Mel Watt, the incoming Director of FHFA, announced his intention to delay the implementation of "g-fee" hikes and changes to the risk-based pricing plan announced on Dec 9th.  This promises to be the first volley in an ongoing course change for the FHFA between outgoing Director DeMarco and Watt. 

Approximately one week after the announcement by Watt, we see premium coupon (4.5s, 5.0s) MBS underperforming their hedges by about a quarter point - but pretty much in line with underperformance for lower coupon MBS as well.  Because these fee changes were not slotted to take effect until the end of 1Q14, we hadn’t expected to see much of an immediate impact on pricing deriving from this announcement.


Longer term, the importance of this decision is that it confirms the upcoming policy direction for the FHFA will clearly be steered toward supporting the availability of credit to homeowners versus accelerating the exit of Fannie and Freddie from the mortgage market.  All else equal - which is rarely the case - this will delay the return of private capital into the mortgage market and support the primacy of agency-backed mortgages in the mortgage market today.


Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500
@Tradex_Global

Wednesday, December 18, 2013

FLASH UPDATE: MBS tightening ahead of the FOMC announcement at 2pm today - Housing Starts Portent Taper Today

On Dec 9th we discussed on this blog the “cornucopia’ of economic data during the prior week pointing to Fed Tapering in the near term and advised investors to await further confirmation via both data and “Fed-speak”.  Today, as of now, we have/will receive both.

This morning we received Housing Starts for Sept, Oct and Nov as we had been having a blackout on this statistic for the past 3 months.  Housing Starts for November crossed the psychologically important 1MM mark, up 23.5% from the last published value in August!  With mortgage rates now above 4%, this puts to rest the FOMC’s fears in September about "Tapering" too soon.  Mortgage rates have now risen +100bps since the Fed first suggested in 2Q13 that "Tapering" may begin prior to year-end and the housing market has now proven robust in the face of such higher housing costs.

Treasury yields have risen about +10bps since the release of strong economic data earlier this month.  However mortgage spreads have tightened about an equal amount.  Clearly investors are handicapping a near-term Tapering of Fed QE and are expecting it to be biased more toward the Treasury market than in mortgages.  Mortgages today are performing extremely well across the coupon stack.  Mortgages are up slightly stronger in the belly of the stack and slightly stronger in 30 year mortgages versus 15 years.  FNCL, FGLMC and GNMA 4s are leading the way, each up about +7 to +8 ticks as of this writing (1:00pm).
 

At 2:00pm there is a risk that the Fed announcement could disappoint investors.  However we expect a strong upward bias in Treasury yields and rally in mortgage yield spreads to Treasuries should the Fed announce a "Tapering", or an intention to soon "Taper", its QE program more biased toward Treasuries than mortgages.

Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500
@Tradex_Global

Monday, December 16, 2013

FLASH UPDATE: Mel Watt-led FHA is expected to have non-uniform impact on the MBS market

With the confirmation last week of Mel Watt as head of the FHA, mortgage investors are watching closely and awaiting possible policy changes and their impact on the mortgage market.  The Obama administration is strongly supportive of policy that continues to promote refinancing and low income housing in particular.  Here are a few mortgage policy dynamics to be aware of:

One of the most important would be the extension of the HARP cutoff date for FNMA/FHLMC conforming loans from June 2009 to June or December 2010 and allowing for borrowers to refinance mortgages that had previously been HARP refinanced.  At current levels of mortgage rates this could raise refi speeds for 4.5%  and 5% coupons by 5 to 14 CPR.  This would have a deleterious effect for mREITS who hold significant balances in higher coupon mortgages.  But it would be beneficial to mortgage servicers who process refinancing activity.  Perhaps more importantly, the presumption is that the FHA would match any cut-off date extension by the FHFA, which would have an even larger impact on GNMA collateral.  

The FHFA could reduce or eliminate Loan Level Pricing Adjustments for low FICO, low LTV loans which could also boost speeds by 5 to 9 CPR in higher coupon MBS.  Currently, this group of borrowers represents about 29% of HARP eligible borrowers; new borrowers in this cohort could see their mortgage rates drop by over 1.00%

Lastly, under a Watt-led FHFA, the likelihood for reducing the loan limits for what qualifies as conforming FN/FH collateral would almost certainly go down-, which would not be helpful in re-accelerating the return of the non-agency mortgage market.


Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500
@Tradex_Global

Thursday, December 12, 2013

FLASH UPDATE: Who Will Be the Last One Holding Junk Bonds when the Music Stops?


Who Will Be the Last One Holding Junk Bonds when the Music Stops?

“Troubled borrowers hide behind a wall of yield-hungry investors.”  Low interest rates on benchmark bonds have driven investors to the worst-of-breed CCC and B-rated junk bonds.  Companies have taken full advantage of this investor appetite by issuing $16.5 billion worth of PIK bonds.  These bonds allow the issuer to make “payments-in-kind” with additional bonds (more IOU’s) in liu of cash payments.  According to the Bank for International Settlements, new PIK bond issuance is nearly triple the amount issued in 2012.  The $16.5 billion has now far surpassed the $11.1 billion issued in 2007, which coincides with the end of the last credit cycle.  BIS also indicated that about 30% of issuers that issued PIK bonds in the previous cycle have already defaulted. 

Record sales of PIK junk bonds are triggering uneasiness among international regulators concerned that investors will suffer losses when central banks tighten monetary policy.  BIS is nervous about the artificially low default rate and what happens to the companies that have been hiding behind the wall of liquidity.  “What is happening in corporate markets is unusual,” said BIS.  “It is as if the typical relationship with (the) macro economy has taken a holiday.  Spreads are low and so are default rates…” (for now). 

We here at Tradex have maintained that we see cracks in the individual junk companies, long before the headline default rate is flashed all over Squawk Box.  There are a lot of these “bad” bonds and a very small appetite from banks and dealers in the current banking environment.  So, who will be the last one holding these when the Fed’s music stops.  

Michael Beattie
Chief Investment Officer 

Monday, December 9, 2013

FLASH UPDATE: Cornucopia of economic data last week points to Fed Taper - Advise Caution for the Short Term

Last week we saw a veritable cornucopia of data releases - all pointing toward safe passage to the advent of Tapering by the Fed later this month.  Wednesday’s ADP payroll data showed growth by +45k jobs, more than expected in November along with a +54k revision upward for October.  Thursday saw initial jobless claims undershoot expectations by -22k and GDP (Q/Q) swell to a robust 3.6% annualized.  Friday completed the trifecta with headline unemployment dropping to the magical +7.0% and Univ of Michigan confidence survey rising to +82.5 versus expectations of +76.

Not surprisingly, treasury yields rose for the week by +6 to +7bps uniformly across the 5 to 10 year part of the curve.  This reflects expectations of a slowdown in purchases of $45bln/month in the Treasury market.

However, mortgages tightened by -7 to -10 bps on the week from their recent highs for both 15 year and 30 year mortgages.  This reflects a market expectation that the pace of Tapering will be skewed toward more Treasury than in the mortgage sector.   We would advise caution initially as markets can be quite fickle in charting a new course until confirmed with “Fed-speak” later this month.




Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500

@Tradex_Global

Thursday, December 5, 2013

FLASH UPDATE: Procrastination Can Burn You


Procrastination, in delaying being short high yield, is like standing too close to the fire

I have recently read a short piece in The New Yorker discussing “procrastination”, which effects all of us in one form or another.  It is interesting that George Akerlof authored the piece.  His wife, for those that are unaware, is Janet Yellen (our soon to be new Federal Reserve Chairperson).  She may want to read closely what her husband has written on the subject of procrastination when she thinks about “Tapering”.  I have spoken to several very smart investors, many of which are much more educated than myself, but regardless of the Ivy League pedigree or the Nobel Prizes on the mantel, we can all have a case of procrastination from time to time.  

The current investment theme we are focused on and excited about is shorting high yield companies who never procrastinated when “free” money became available.  I am surprised by some potential investors’ theories which suggest that they can time the fall in high yield…or is it just procrastination rearing its big ugly head?  

George Ainslie, the well-known psychiatrist, psychologist and economist, wrote in an essay that procrastination “…is as fundamental as the shape of time, and could well be called basic impulse…”.  The word procrastination itself means “to put off for tomorrow”, and entered into the English language early in the sixteenth century.  By the eighteenth century, Samuel Johnson was describing it as “one of the general weaknesses” that prevails in all great minds.  In a study done at the University of Calgary, the percentage of people who admitted to difficulties with procrastination quadrupled between 1978 and 2002.  

In this light, I now understand why so many colleagues and intelligent investors sometimes procrastinate in making fairly obvious decisions.  I thought it was timing, but maybe in some cases I was wrong and it’s just old fashioned procrastination.  As for me, I really hate to put off what I can do today for tomorrow.  This probably comes from my strict Grandmother and all of her values.  

I can honestly say that two of the best trades I have been involved in would have been missed if I had been a procrastinator:  1) Short Subprime, and 2) Short HY.   Both trades were so cheap to have on that I never really thought about waiting for tomorrow when, for pennies, I could have it on early when bonds were at the highest levels, allowing us to maximize the returns. These two trades were the most profitable trades for myself and our investors in the crisis period.  (Of course we should have had double the size).  I encourage everyone who is looking seriously at our Short-Biased High Yield Portfolio to get invested now (or soon) as bonds are generally at their mathematical peaks and fundamentals in the HY companies we focus on are eroding fast.

Best Regards,

Michael Beattie
Chief Investment Officer


FLASH UPDATE: MBS Continue to Underperform on ADP Jobs Data

The ADP Payroll yesterday showed better than expected employment gains for November.  The monthly ADP report is always closely watched as it foreshadows the monthly Unemployment Rate to be published on the first Friday of every month – November’s unemployment numbers will be published this Friday.  The 215k jobs gained for the month by ADP overshoots the survey expectation of 170k and last month’s employment gains for ADP were revised upward by 54k jobs as well.  The strong report points to a strong employment report on Friday and modestly increases the likelihood of a Fed Taper at its December meeting.


Mortgage spreads to 7 year treasuries have now widened ~10+bps since the recent lows seen in at the start of last month.  Continuing what has been a recent theme, until and unless data or announced policy changes the trajectory of the recent  spread movement in the mortgage market, we expect spreads to continue to slowly drift wider.