C.M.O. 5.4.2009

Credit Market Overview
May 4, 2009

The precipitous drop in real estate values, both residential and commercial is a pretty good indicator of just how much fluff the easy credit in the first part of this decade created. Confirmation of this, as if some were needed, can also be found in the art market. In 2006 a single painting by Pablo Picasso sold at Sotheby’s for an even $100MM.

This coming Tuesday, when the spring auction season starts, there are a dozen works, that if all sold at the high end of their estimates, might just make it to that same 9 figure number. The estimate for the entire spring auction series is expected to generate somewhere between $179MM-$256MM versus $411MM last fall and $742MM a year ago. What a difference a year makes!

For those of us who can only dream of making $100MM in a life time let alone pay that amount for a little binder, pigment and canvas, mortgage rates matched the record low rate set two weeks ago of 4.78% for a 30-year fixed rate loan according to Freddie Mac. In its quarterly refinancing report FRE said that about half the borrowers who refinanced lowered their annual interest rate by about 20%.

What makes this a little more interesting, if you can stand the suspense, is that the move in mortgage rates occurred during a week when the yield on the 10-year Treasury, the note used as the benchmark for mortgages, rose to its highest level in 2009. The latter caused in part by the record $71BN in 10 and 30 year securities to be auctioned by the Treasury in its May refunding. The other factor pushing Treasury yields higher was the sale of those securities by mortgage investors.

Investors in the mortgage market use Treasuries to adjust the duration of their portfolios. As rates in general rise the duration of mortgages tends to lengthen as less refinancings occur. To counter this effect players in the mortgage market will sell Treasury securities. The move higher in the 10-year note yield caused some of this duration adjustment. “It’s either happening, or it’s the fear of it happening and people not wanting to get caught in the trade”, Adam Brown of Barclays Capital said.

In this case it seems to have been caused more by the fear as the move down in mortgage rates would only serve to increase the number of refinancings, bringing in the duration of the mortgage backed securities. The movement in opposite directions for Treasury yields and mortgage rates also served to narrow the spread between those two securities and as we all know from reading this column every day narrower spreads occur when there is less perceived risk in the market place.

Enjoy the week.

Jim Delaney