Wealth of Women

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A lot of analysis that gets written will refer to "technical factors" driving valuations.  What this is referring to are situations where unique factors are impacting valuations.  The classic business school example that comes to mind is the unique case of "flower bonds."  These were special issues of low-coupon U.S. Treasuries that could be used to pay Federal estate taxes at par value; as a result, they traded at extremely low yields.  The unique nature of the mortgage and means that there are a number of situations that affect market levels, and understanding them can help lenders and secondary market managers do a better job of managing and hedging their pipelines.

An MBS-specific example of technical factors is so-called "convexity" buying and selling.  This refers to the fact that large bond market rallies and selloffs tend to be self-perpetuating; big market moves often push yields beyond levels that can be explained by changing economic expectations. Readers of the MBS Commentary channel will have encountered this phenomenon as "snowball" selling or buying. 

To understand this, we first need to review several market fundamentals.  Remember that the MBS market is huge, second only in size to the Treasury market.  Roughly $5.5 trillion in MBS issued under the auspices of Fannie Mae, Freddie Mac, and Ginnie Mae are outstanding.  (The MBS market used to be larger than the Treasury market, but a few years of trillion-dollar deficits changed that dynamic.)  

In addition, mortgages are prepayable at the option of the homeowners.  Any investor or portfolio manager holding has to make some judgment on how rapidly their holdings will prepay.  (That's why prepayment metrics are referred to as "speeds.")  When interest rates decline, investors will assume faster prepayment speeds for their holdings, which means that their portfolios are effectively getting "shorter" in both average life and price sensitivity to rate moves, i.e., duration.  If rates rise, the opposite happens; investors assume slower prepayments, which in turn extend the average lives and durations of their holdings.

This means that investors both large and small need to adjust the duration profile of their portfolio when interest rates change, especially if they are "index" investors that track the duration of major market indices.  Since rate declines (i.e., rising bond prices) are associated with shortening durations, investors need to buy assets in order to maintain their portfolio's duration, perpetuating the rally.  Alternatively, rising rates are associated with the selling of duration (either MBS or any fixed-income asset with positive duration) by investors, pushing bond prices still lower.  

These activities tend to push market moves beyond what would be associated with simple changes in expectations, and are referred to as "convexity buying" or "convexity selling" because they result from the negatively-convex nature of MBS.  (I'll discuss convexity in a future post.)  Understanding this phenomenon can help investors gauge the intensity and duration of market moves, and adjust their responses accordingly.  (Note that the fact that the Federal Reserve holds over $1 trillion of agency MBS has dampened this response a bit; the Fed is a "passive" investor and does not adjust its holdings to changing rate levels.)

Next Time:  Technical Factors Part 2: Dollar Rolls

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As an FHA approved lender, you are required to have and implement a Quality Control Plan (QCP) . As many lenders have probably figured out, the QC review process is not necessarily intuitive and easily discernible as they would like. For example, are you fully aware of the sampling requirements – how to meet them – and how to do so in a cost efficient manner? You are probably able to readily identify what it costs for your staff or contractor to complete the monthly QC process, but can you quantify the financial and reputational risk if you fail to implement the Plan or not do so in compliance with FHA requirements? It can also cost you an audit by the Quality Assurance Division or HUD’s Office of Inspector General, a Credit Watch or Direct Endorsement authority termination...()

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Relatively late in the domestic session yesterday, a few details finally emerged from the conference call between Greece and the Eurogroup. They were rather lackluster and underwhelming, including a generic vote of confidence that Eurogroup will be able to render a decision on the Greek bailout on Monday Feb 20th, and that Greece has done what it needed to do in order for such decisions to be deliberated. So really, what we're left with is that yesterday's conference call amounted to a "delivery receipt" by the Eurogroup, acknowledging that they've received "the message" from Greece and the Troika, but that's it. No reply. No action. No vote. Just a "yeah, we hear ya! We'll talk about it and get back to you." Incidentally, that "get back to you" day--Feb 20th--is a domestic bank holiday and...()

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Citizens of the U.S. have well-documented accents, but do you ever wonder what linguistics majors do when they graduate? At certain phases of the economic cycle, loan originators often wonder about how bankruptcies impact credit ratings. Now many wonder how loan modifications impact bankruptcies . Yesterday this commentary noted several upcoming conferences sprinkled around the nation. The problem with any list, whether it is investors, best teen movies, vendors, Jewish football players, conferences, favorite BBQ joints, broker dealers, warehouse banks, is that producing an all-inclusive list is nearly impossible. Of course I received information on several conferences & events that I had not listed. For example, the MBA's National Advocacy Conference is April 18-19 in Washington DC . ...()