Lending Club & Alibaba form Alliance; The Current State of the Secondary Markets

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What's ahead of us this month? Valentine's Day, that's what. "The Hallmark Holiday" is quickly approaching and hopefully you have bought your loved one a deserving gift, not something like a door mat. In 2012, there were 1,379 U.S. candy manufacturing establishments, over 14,000 florists (guys, that's a store that sells flowers), and over 23,000 jewelry stores in 2012. In 2013, the median age for first time marriage was 29 years old for men, compared to 26.6 years old for women. In 2013, about 52% of people 15 years and older reported being married and 68.6% of people 15 and older have been married at some point in their lives, either currently or previously. (What states prompted the Census Bureau to use the age 15 as a cutoff?)

And what is going on in the secondary markets?

For the jumbo prime outlook for 2015, net issuance of jumbo prime deals in 2014 was anemic at best, and we ended the year with approximately $8B of net issuance; that marks a decline from 2013 in which $13.3B of jumbo prime securitizations were issued. There are a few reasons for this slide: (1) arbitrage just isn't there as non-agency deal execution is still not as attractive as agency execution; and (2) strong demand from banks for portfolio loans has driven jumbo rates to levels that are less attractive for securitization. Also, as a few analysts have pointed out, even though the prepay curve has flattened over time, jumbo prime pools are still more "negatively convex" than agency jumbo pools--generally speaking convexity helps investors anticipate what should happen to the price of a particular bond if market interest rates change. So where does this leave expectations for 2015, well much like salaries and wages, many mark 2015 production to be near 2013 levels, and analysts are predicting jumbo prime deal issuance to 13-15B. Why the relatively positive outlook? Mainly attributable to expected additional issuance from REITs, with a slight increase in securitization activity from banks.

BlackRock Inc., a type of peer-to-peer lender, plans to sell the first rated securities backed by consumer loans arranged through Prosper Marketplace Inc. According to a Bloomberg report, about $281 million of the bonds may receive an investment grade of Baa3 from Moody's Investors Service, while $45 million may be rated Ba3. Although a grade of Baa3 sounds more like some chemistry element I failed to learn in high school, it is in fact the lowest rating of investment grade Moody's Long-term Corporate Obligation Rating. Debt instruments rated Baa3 are subject to moderate credit risk. They are considered medium grade and as such may possess certain speculative characteristics.

There's been more and more talk regarding peer-to-peer platforms as consumers turn to these outlets to consolidate debt and finance home repairs. Recently, institutional investors have gotten in on the act, helping fuel a surge in originations. BlackRock's main products are unsecured consumer loans for as much as $35,000 and as long as five years.

The appeal of floating-rate securities to investors is pretty straight forward, especially now, with rates at near bottoms; with a fixed-rate bond, when rates rise, the value of the bond falls because newer bonds pay more. But when interest payments rise along with market rates (as in the case of "floaters"), the value of the security remains stable. In January 2014, the U.S. Treasury held its first auction of a two-year floating-rate note (FRN's as they have become known), which pays a fixed spread over the floating thirteen-week bill rate rather than a fixed coupon. The New York Fed followed this initial auction of 2yr Floating Rate Notes, and has since published their finding on overall participation by dealers and subsequent secondary markets.

Recently I got the chance to have lunch with a secondary marketing guy I haven't seen in a while. We talked about a few of his concerns over the span of lunch. The first being mortgage volatility in the coming years, and the fact that we may look back at the last few years of mortgage banking as "peaceful." I don't know, and I certainly don't believe my prognosticating abilities rival my trusty Magic 8 Ball, however, there are many factors which support his concerns. His second concern was something about the curly fries on the menu having lower arb value against the regular fries....I'll let him and his psychologist hash that one out, though.

All I know is that if you ask anyone, in any market, what their biggest concern is, I'm sure a very common answer would be volatility. Volatility ultimately leads to higher transaction costs and higher transaction costs ultimately lead to lower profits....I thought of him when I read Bloomberg's article Mortgage Bonds in Worst Start Against Treasuries in 18 Years in which Jody Shenn writes of the flight-to-quality? "Government-backed U.S. mortgage bonds are off to their worst start to a year relative to Treasuries since at least 1997 as investors in the $5.5 trillion market brace for a surge in homeowner refinancing. Returns on mortgage securities guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae were 0.6 percentage point less than those on similar-duration government debt this month through yesterday, according to Bank of America Merrill Lynch index data. Ginnie Mae securities, which package Federal Housing Administration loans, have underperformed Treasuries by 0.9 percentage point." The general belief is that refinancing is accelerating after mortgage rates fell to its lowest levels since spring 2013. Investors in mortgage-backed securities are betting this trend will continue as changes to government programs, including a lowering of insurance premiums on new FHA loans, were announced earlier this month.

With all this going on, it is hard to concentrate on what rates are doing. But agency MBS prices closed mostly wider (meaning they lagged Treasury securities) on decent volumes Monday. Volumes picked up after the storm impacted last week's business. We'll have Factory Orders here in the United States, but the news overnight focused on the Bank of Russia responding to pressure from executives of commercial banks and industrialists by lowering its key interest rate. Australia did the same, as has many other countries, pushing its currency to an all-time low. Given all that, the only scheduled news here will be Factory Orders - usually not a big interest-rate mover.

 

For numbers, the risk-free U.S. 10-yr T-note closed Monday at 1.67% and this morning is worse by .5 with its yield up to 1.72% (still pretty darned low) and agency MBS prices are worse .250-.375.

Executive Rate Market Report:

Bonds and MBSs opened weak this morning after yields edged a little higher yesterday. After the swift decline in interest rates over the last two weeks interest rates have momentarily lost their driving influences of Greece and the drop in oil prices. Crude oil has increased over $5.00 in the last three sessions and in Greece the new government appears to be retreating from its hard line on the country’s debt. The government wants to exchange existing debt owned by the European Central Bank and the European Financial Stability Facility for new obligations linked to economic growth, the new government is seen to be relaxing its stand to end the austerity if a plan can be resolved to allow the country to avoid imposing a formal losses on creditors. The Greek issue was one factor that led to the decline in US 10 yr notes as investors were fearing the potential of a Greek default and exit from the EU.

Another key for the rate declines; the rapid decline of crude oil that led to fears of deflation and removed concern that inflation would edge close to the Fed’s target. Crude led almost all commodities lower. Crude is finally facing a corrective retracement with a strike of refineries that lessened supply and a decline in demand. The strike likely more symbolic than crucial provided a reason to take profits by traders and investors took some off the table. Technically crude had been very oversold and ripe for a pullback. The overall fundamentals of too much supply and less demand is still valid and will likely reassert themselves once the price becomes high enough to attract sellers. In the meantime another convenient reason to back off selling.

Inflation around the world continues to fall; a new report from the OECD (Organization for Economic Cooperation and Development) in a recent report said the annual rate of inflation in its 34 members fell to 1.1% in December from 1.5% in November, the lowest level since October 2009. Mostly due to the decline in oil prices according to the report but also due to the weak performance of global economies. As long as inflation remains dangerously low the bond markets will accept lower rates. When inflation is low, companies, households and even governments have a harder time cutting their debt loads, a particular problem for a number of highly-indebted nations in the Eurozone. And while very low inflation or falling prices can help boost real incomes, it can also make households and businesses postpone spending and investment which is what we are experiencing now with the US consumer. The Federal Reserve, widely expected to begin increasing rates this year, may have to delay the increase for longer than markets presently believe.

At 9:30 the DJIA opened +110, NASDAQ 21, S&P +10. 10 yr at 1.73% +5 bp and 30 yr MBS price -22 bps from yesterday’s close and -3 bps from 9:30 yesterday.

At 10:00 Dec factory orders were thought to be down 2.2%, orders declined 3.4% and Nov orders originally reported down 0.7% was revised to -1.7%.

Jan auto and truck sales are being reported this morning; so far GM and Chrysler reported stronger sales than forecasts.

The bellwether 10 yr at 1.74% is bothersome for the near term but the wider perspective remains constructive; although we don’t want to ride it out the 10 has the potential of climbing to 1.82% before the technicals would turn to a bearish outlook. The low rates globally are still a major factor for US treasuries; the German 10 yr bund at 0.33% and the Japanese 10 yr at 0.36%. The situation currently has investors and traders backing off but we will stay with our bullish rate outlook. That said, , as we noted yesterday the risk of floating has increased since last week. Friday the Dec employment report, usually the interest rate markets tend to adjust going into the always volatile data.

PRICES @ 10:00 AM

10 yr note: -21/32 (66 bp) 1.74% +6 bp

5 yr note: -9/32 (28 bp) 1.24% +5 bp

2 Yr note: -3/32 (9 bp) 0.50% +4 bp

30 yr bond: -59/32 (184 bp) 2.34% +8 bp

Libor Rates: 1 mo 0.171%; 3 mo 0.253%; 6 mo 0.357%; 1 yr 0.620%

30 yr FNMA 3.0 Feb: @9:30 103.20 -22 bp (-3 bp frm 9:30 yesterday)

15 yr FNMA 3.0 Feb: @9:30 105.16 unch (+14 bp frm 9:30 yesterday)

30 yr GNMA 3.0 Feb: @9:30 103.55 -14 bp (-1 bp frm 9:30 yesterday)

Dollar/Yen: 117.60 +0.03 yen

Dollar/Euro: $1.1441 +$0.0100

Gold: $1268.40 -$8.50

Crude Oil: $51.02 +$1.45

DJIA: 17,542.27 +181.23

NASDAQ: 4702.98 +26.29

S&P 500: 2037.40 +16.55 

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