US Housing Market and Agency MBS

The United States’ housing market is believed by many to have reached its bottom, and recent data releases continue to point toward the beginning of a recovery. Currently, several interconnected policy tools are trying to balance aiding borrowers by reducing refinancing frictions while ensuring borrower credit risk is appropriately priced. Regulatory policies have created a nuanced Agency mortgage market which is providing opportunities for bottom-up security selection.

The Housing Market Recovery

• Home price indicators have climbed from trough levels and forecasts indicate continued improvement ahead
• Housing inventory levels and the pipeline of delinquent mortgages have declined and sales have gradually increased
• A strong rental market has encouraged institutional capital inflows

Regulatory Initiatives

QE3

• The Fed is expected to purchase $40 billion per month of Agency MBS and continue to reinvest paydowns
• While secondary market mortgage rates have moved lower in response to Fed purchases, the primary rate (the rate offered to borrowers), has fallen at a slower rate, reducing the incentive to refinance

Government-Sponsored Enterprises (GSEs)

• Fannie Mae and Freddie Mac currently underwrite over 90% of new mortgages
• Since September of 2008, the GSEs have been in conservatorship, resulting in the Treasury effectively owning 79.9% of each entity
• While under conservatorship, the GSEs are being encouraged to increase guarantee fees to ensure adequate compensation at the loan level for their credit insurance
• As GSE balance sheets shrink, their ultimate fate remains uncertain
• Recently, the Bipartisan Policy Center Housing Commission released recommendations for policy makers to consider for eventually reducing the role of the GSEs in the mortgage market

Home Affordable Refinance Program (HARP)

• A program which increases the ability of qualified borrowers to refinance by removing credit barriers and streamlining processes
• Regulators have repeatedly modified the program to open new pockets of demand for refinancings

Agency MBS Investment Opportunities

• The above regulations have created opportunities where prepayment and credit risk are more heterogeneous than ever
• In addition, a stabilizing housing market will moderate the risk of new government programs and provide bottom-up security selection opportunities

At IR+M, we do not make investment decisions based on macroeconomic or housing market forecasts. Within the mortgage sector, our current focus is on Agency fixed-rate collateral in specified pools and CMO form as well as Agency Hybrid ARM specified pools. We do not use leverage and rely on our bottom-up security selection expertise to invest in collateral with attractive prepayment characteristics.

¹Source: Bloomberg

²Source: Barclays

As of 2/27/13. The views contained in this report are those of IR+M and are based on information obtained by IR+M from sources that are believed to be reliable.  This report is for informational purposes only and is not intended to provide specific advice, recommendations for, or projected returns of any particular IR+M product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Income Research & Management.