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Valuation Commentary - July '06
TBAs, SATO & Fannie 7.0
by Alex Levin
Those who follow AD&Co’s weekly market analyses should have noticed a recent richening of FNCL 7.0. In just 6 weeks, Libor OAS (LOAS) fell from +13 bps to – 36 bps. What caused this significant change? How credible is it? Do major brokers agree with us?
The price of this coupon has dipped slightly, from 102.50 to 102.34, remaining somewhat consistent with the small current coupon’s rise from 6.19% to 6.28%. It is easy to see that the LOAS drop is caused by a dramatic change of the assumed WALA for the TBA, not the price. The median age assumption has quickly gone from 40 months down to 8 months as follows: on June 9, median WAM was 319; the next week it became 332; on June 30, it already rose to 346, etc. Out of 11 major brokers contributing to Bloomberg’s VALL screen, only two currently believe that moderately seasoned pools will be delivered into TBA 7.0; six brokers thought so back in June.
Clearly, newer premium pools should trade at a much lower price than the seasoned ones; yet the brokers’ median for LOAS that we compile regularly, but do not disseminate, has gone down by only 10 basis points from 0 to -10. Therefore, the market makers apparently don’t think TBA 7.0 has richened to the same extent as AD&Co. Who is correct?
TBA Assumptions and SATO
Since AD&Co does not make the market and has no access to the full brokers’ pool inventory, we analyze the market using the median assumptions on WAC and WAM loaded from Bloomberg. We consider this method to be objective and practical but, admittedly, not very accurate.
To avoid spurious valuation effects when modeling the TBAs, we exclude the SATO effect (normally presented in our prepayment model). The SATO effect suggests that, all else equal, pools originated above prevailing market rates may be credit-impaired and will be temporarily slower in refinancing than the usual zero SATO pools.
