Flash Update - Liquid Real Estate

We believe prepayments will ‘shock to the downside’ in the 2^nd half of this year.  If the bond market stabilizes in a 2.5% to 3.0% 10-year zone, we believe we no longer need a further sell-off to create sharply slower prepayments for most coupons.  In our opinion, only a strong reversal to lower rates would derail strong performance in the second half of the year for IOs.  If the economy keeps improving (inflation heads higher and/or unemployment heads lower), rates have much more room to go higher from current levels.  Often the biggest returns in the mortgage derivatives market have been made owning IO product as the mortgage market exits a refinancing wave.  It’s been a longer than expected wait, but we’re of the belief that this scenario will continue to unfold in stages in the latter half of 2013 and into 2014.  The charts above show some specific vintage IO performance history.