THE BASIS POINT

$1.1t 2nd Mortgage Problem, Distressed Home Sales 29% of Market, Banks & Hedge Funds 40% Of MBS Volume

My clock radio went dead, so I was faced with the usual question, “Do I pay to have it repaired, or do I buy a new one?” I went to a local repair shop, and on the door was a sign that said, “WE CAN REPAIR ANYTHING. (PLEASE KNOCK – THE BELL DOESN’T WORK!)” Needless to say, I have a new clock radio.

$1.1t 2nd Mortgage Problem
It is also going to be hard to fix the potential problem with 2nd mortgages. There are roughly $1.1 trillion in second-lien mortgages out there. A research firm in New York believes that Bank of America, Chase, and Wells, who combined own about 40% of them, may have to set aside an additional $30 billion (matching their expected profits for all of 2010!) to cover possible losses on home-equity loans. (Home equity loans are often open-ended, as opposed to closed-end 2nds.) But of course banks have already set aside billions to cover bad loans – will it be enough? Of course second-lien loans are a hurdle when modifying first loans since first mortgages usually can’t be modified or written down because lien priority dictates that junior loans be erased first. As mentioned above, analysts are arguing whether or not the billions held in reserves will be enough. Bank of America holds $138 billion of home-equity loans with $112 billion of second liens. Wells Fargo holds $123 billion of home-equity loans, with about $103.7 billion in a junior-lien position, while CitiGroup’s portfolio is “only” about $49 billion. For the complete story.

Distressed Sales One-Third of Home Market
Distressed home sales are once again approaching a one third share of the real estate market for existing homes, depressing home price trends and indicating that the housing market is not yet out of the woods. According to a report issued by First American CoreLogic, the sale of homes that could be considered distressed accounted for 29% of all home re-sales in January. This was the second highest share recorded for these sales, exceeded only by the peak of 32% reached a year ago, and compared to periods prior to the fourth quarter of 2007 when distressed sales constituted less than 5% of the resale market.

Fannie/Freddie Buyout Program
The Fannie & Freddie buyout program continues to give investors (not so much originators) something to talk about. Of course the delinquent buyouts are increasing prepayment speeds for older pools of mortgages, but limited, if any, impact on the projections on prepayments for new pools of mortgages. I was informed by one of the folks at MIAC that SATO (“Spread at the Time of Origination”) is often useful in estimating credit risk: a higher SATO normally meant that the borrower was more credit impaired or at a higher risk of default. Of course, subprime loans always had a higher spread, due to the higher risk, but loans that qualify under Freddie & Fannie guidelines do so for a variety of reasons. In the past built into the prepayment projections on premium TBA’s would be some degree of additive default/buyout speed estimates resulting from the fact of higher buyout probabilities and thus higher baseline speeds baked into the prepayment projections: weaker borrowers lead to higher delinquencies and default probabilities. “The market has since moved more towards looking at current LTV’s in combination with such collateral attributes as FICO, documentation, and product type with SATO becoming more of a lagging indicator.”

Stocks and Bonds Both Rally
Both the stock and bond markets improved yesterday, especially mortgages. Treasury securities, like the 5-yr note, would improve slightly, and mortgages would not only follow but improve more. With low volatility, tighter spreads, and supply (origination) heading down, no wonder! Remember predictions of mortgage Armageddon when the Fed stopped buying after 15 months? Of course, with stocks over 11,000, a $50 billion Greek rescue plan in place, and continued positive economic information one would think the bond market wouldn’t be rallying… but it is. (Speaking of Greece, the country’s cost of financing is heading higher. Any investor that bought Grecian debt lately is sitting on a loss – rates are higher – and we know that throwing money at a debt crisis simply turns a short-term crisis into a long-term deficit. Greece just sold $1.6 billion of short term bills, adding to the deficit, and may lead to more uncertainty in domestic banks and may hasten the intervention plan announced March 26th.)

Banks & Hedge Funds Are 40% Of Mortgage Bond Volume
Originators and investors who sold mortgage pools, but didn’t have them yet, are buying back their hedge positions, and outright buying by hedge funds, money managers, and investors is pushing mortgage rates lower. According to TradeWeb, banks and hedge funds currently account for over 40% of the MBS trading volume, a recent peak. It appears, through antidotal evidence, that locks are picking up: investors’ phones are ringing, and the move in rates appears to have pushed some fence-sitting borrowers into locking. The upcoming economic data for March should show decent growth and low inflation. Retail Sales are expected +1.1%, Industrial Production 0.7% higher, the CPI should be flat overall and up 0.1% for the core. Fed Chairman Bernanke may not have much new to say, but testifies before the Joint Economic Committee, and the Fed releases its beige book. Today’s Trade figures ($39.7 billion deficit) don’t normally push rates too much and after the 5:30AM number the 10-yr is at 3.83% and mortgage prices are better by about .250.

Daily Humor
“It’s just too hot to wear clothes today,” Jack says as he stepped out of the shower. “Honey, what do you think the neighbors would think if I mowed the lawn like this?”

“Probably that I married you for your money,” she replied.