09/17/2010

Rally Continues for Mortgage-Bond Values

Mortgage-bond values are back on the upswing, with market players forecasting gains of 3-5 cents on the dollar by yearend.

As trading faded in late August, the prices of non-agency home-loan securities retreated by an average of one cent on the dollar. But those losses were quickly recovered as secondary-market sales picked up during the first week of September. Another one-cent rise followed this week, driving values to their highest levels of the year.

Now, market players foresee the gains continuing until yearend.

The factors driving prices now are similar to those at work prior to August's brief swoon - chiefly, demand exceeding supply. As the year has progressed, the volume of bid lists circulating each week has dropped while investor interest has grown.

Indeed, the weekly volume of paper posted on "bids-wanted-in-competition" offerings exceeded $3 billion on several occasions earlier this year. But the weekly average has recently dropped to about $1.6 billion, according to data compiled by Jefferies & Co. trader Jesse Litvak.

This week stands to see a higher volume. More than $1 billion of private-label mortgage paper traded on Sept. 13 alone, although bid-list sizes already were beginning to shrink in the following days.

Meanwhile, some large money managers are using capital that previously might have gone toward equity investments to buy mortgage securities. That's because some of their clients are getting tired of settling for subpar stock-market returns. "Given the supply-and-demand situation, I can't see prices coming off," one trader said.

Prices are most likely to rise among mezzanine-level bonds or those backed by less desirable assets, as the top-graded pieces of deals with well-regarded asset pools already may have hit resistance levels around four cents over par. Plus, many investors are looking down the capital structure for bigger yields.

Among the products that saw one-cent gains this week:

*Subprime-mortgage securities that would place bondholders third or fourth in line to receive payments, which now are trading at 70-75 cents.

*Five-year prime-quality deals, where double-A or single-A classes are fetching 90-95 cents and double-B positions are at 85-89 cents.

*Securitizations of alternative-A credits, where senior five-year issues are going for 84-88 cents and lower-rated pieces are at 60-65 cents.

With such increases comes the risk that additional secondary-market sellers will be lured into the market, creating an overload of supply that would cause yields to whipsaw. Traders don't see that happening now, however. That's because a freeze in new-deal production since mid-2007 has left market players with a finite universe of issues to trade - a pool that is shrinking as transactions mature or go bad.

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