Exhaustive Trading Desk Notes: Secondary Bond Analysis and MBS/MBS Market Trends

Secondary Market Expansion: The trading desk has recently added several hundred million dollars in secondary bonds to the position, moving away from the usual issuance focus.
Primary Drivers: Treasury Option-Adjusted Spread (OAS) and broad market floaters are currently the primary drivers for new issue deals, particularly for large-sized floating-rate products.
Secondary Bond Varieties:
- Two on Two (2/2): Characterized as very stable, short front bonds with down-in-coupon structures. These were recently acquired from a money manager.
- Five on Six (5/6): Short front bonds with a higher premium and close to par pricing. These are described as "not creatable" and possess positive Treasury OAS. These bonds are approximately $5$ years in duration.
Risk Metrics for Front Bonds:
- The base case volatility and spread reside in the $60s$ to $70s$ range.
- The "Up 300" wall (measuring extension risk in a $+300$ basis point shock scenario) ranges between approximately $5.0$ and $6.5$ years.

Coupon Dynamics: Lower coupon speeds are experiencing steady weakening. Faster turnover in these pools has a negative impact on Interest Only (IO) strips.
Market Selling: Low coupons have been pushed wider due to selling from various accounts, notably featuring one or two specific money managers. The desk recently purchased a block of approximately $160,000,000$ to $170,000,000$ current face value and retraded it.
Freddie Mac Excess:
- Identifer: $377\,C1$ .
- Pricing: Covered at $12$ and $18+$ levels.
Benchmark Benchmarking (FNR 2339 AI):
- Currently holding $100,000,000$ in position, with contact for another $600,000,000$ .
- Market Sentiment: The sector has widened significantly. Turnover projections are currently divergent: Black Knight data suggests no reversion in speeds, while GSE (Government-Sponsored Enterprise) data indicates a potential reversion.

New Issue Inverses: The desk took down $18,000,000$ current face of a par inverse floater from a new issue. Sale efforts are targeted for after the Federal Reserve meeting, assuming no interest rate hike occurs.
Principal Only (PO) Market Activity:
- The desk maintains room for secondary POs but notes a lack of new-issue style POs.
- Buyer Profiles: While money managers are the primary buyers of inverses (which often appear as PO on issuance reports), actual PO buyers are suspected to be servicers with Mortgage Servicing Rights (MSR) or banks.
- Structuring for Banks: Some deals were structured with small coupons because they "repo" better. A bank that cannot legally buy a pure PO may purchase a "PO substitute" with a minimal coupon.

Issuance Volume: Conventional ARM issuance has dropped from approximately $3,500,000,000$ to roughly $2,000,000,000$ this month.
Yield Curve Impact: The flattening of the yield curve over the last two months has reduced efficiency. While temporarily positive for valuations due to lower supply, continued flattening could become a net negative and potentially stifle issuance if liquidity drops too far.
Ginnie Mae 5% 5/1 ARMs:
- Hedge funds have been selling these bonds as the mortgage basis widens.
- The desk has touched about $150,000,000$ of these, selling them primarily to bank portfolios.
GMC Tranche Positions:
- Traded roughly $40,000,000$ to $50,000,000$ last week.
- Remaining position is approximately $60,000,000$ to $65,000,000$ of a $125,000,000$ tranche.
- Pricing: Recently selling at $49.50$ (I-spread).

Bond Specifics: A $200,000,000$ Fannie Mae bond with a $7.06\%$ (or $7.6$ ) coupon.
Pricing and Yield:
- Dollar Price: Approximately $\$99.20$ to $\$99.30$ .
- Z-spread: Low to mid $60s$ .
- OAS: High $20s$ to $30$ basis points vs. Treasuries ( $T+0$ ).
Duration: Effective duration of approximately $3$ years.
Suitability: Deemed an ideal fit for bank portfolios due to the discount dollar price and duration profile. The bond became more attractive following the recent market sell-off.

Market Sentiment: Spreads traded wider week-over-week, influenced by CDX and broader MBS widening. Activity remains muted as CMBS spreads look tight compared to other risk sectors.
Volume: $720,000,000$ in secondary selling; $1,500,000,000$ in origination (DUS and PC).
CMBS Floater Offerings:
- Uncapped, $10$ -year Weighted Average Life (WAL) floaters.
- Discount Margin (DM): Offered at approximately $61.5$ basis points.
DUS Supply Constraints: Supply of Delegated Underwriting and Servicing (DUS) bonds is extremely light. High bank demand for specific coupons like $5.10\%$ or $9.99\%$ is keeping secondary levels elevated. It is noted as a "supply game" rather than a purely fundamental valuation play.

Question (Audience/Trader): Are the buyers of these widened sectors primarily money managers or hedge funds?
Response: The buyers are almost exclusively large money managers. Hedge funds are currently avoiding these sectors due to fundamental concerns. The product is a "natural hedge" for money managers with large inbound coupon cash flows.
Question (Audience/Trader): Is the yield curve flattening going to kill the origination market?
Response: It shouldn’t kill issuance immediately, but if it continues, liquidity providers may step out once valuations wind above $5$ to $6$ basis points, which would eventually hurt the sector's liquid status.
Question (Audience/Trader): Who is buying the PO side if it doesn't show up in HTC (Held-to-Collect)?
Response: It is likely servicers or entities with MSRs. If the coupon is small, it points toward banks or originators who need better repo terms and cannot hold assets that are strictly zero-coupon POs.