By the Numbers

Expect elevated net supply for the remainder of the year

| May 21, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Net supply of agency MBS should be strong for the rest of the year, driven by a strong housing market. If home sales persist at their recent pace, then net supply could average more than $90 billion a month. This is $50 billion a month above the Fed’s current level of net MBS purchases although roughly equal to combined Fed and commercial bank monthly buying this year. Before the pandemic, private investors typically absorbed $20 billion to $25 billion of net supply each month. The excess supply could begin to push MBS spreads wider if the Fed and banks began to step back from MBS.

The pace of home sales has a big impact on net supply in the agency MBS market. For existing homes with a loan currently in agency MBS, a new agency loan is likely to be larger than the loan being prepaid, adding to net supply.  For existing homes without loans or with loans held on a bank balance sheet or in a private securitization, a new agency loan also lifts net supply. New home sales tend to increase net supply for a similar reason, since there is no offsetting prepayment of an existing agency loan. A smaller contributor is the level of cash-out refinancing activity.

Net agency MBS supply tracks new and existing home sales well (Exhibit 1). From 2013 through 2019, a simple model of net supply using existing and new home sales captures most of the changes in net supply during this in-sample period. It only misses the peaks around January 2017 and the second half of 2018. It performed consistently during periods of faster and slower prepayments, and overall explains about 50% of the month-to-month changes in net supply.

Exhibit 1. Modeling MBS net supply using new and existing home sales

A seasonal ARIMA model with new and existing home sales regressors was estimated.  Data from January 2013 through December 2019 was used. One-step ahead forecasts are in-sample, while dynamic forecasts are used out-of-sample. Both series are displayed using a 3-month moving average to reduce noise.
Source: Fannie Mae Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

The model is run out-of-sample starting in 2020. Home sales plummeted at the start of the Covid-19 pandemic, which pushed the model forecast lower. But MBS net supply increased surprisingly during that time, leading the model to underpredict. It is possible that some borrowers moved from private mortgage financing to agency financing at that point, or that banks securitized agency-eligible portfolio loans to build liquidity. However, by mid-2020 home sales had rebounded to levels last seen before the 2008 financial crisis, and the model quickly caught up to the corresponding surge in net supply.

A few scenarios for future home sales lead to three forecasts of net supply over the next 12 months (Exhibit 2). The first scenario uses Amherst Pierpont’s chief economist’s projections, the second assumes home sales for the next year are held constant at the Bloomberg consensus level for April 2021, and the third forecast assumes home sales fall back to the pace from 2019.

Exhibit 2. Net supply could remain elevated for the rest of the year

APS forecast assumes 6.5 million existing home sales and 950,000 new home sales. Consensus forecast as of 5/20/2021 assumes 6.08 million existing home sales and 955,000 new home sales. The “return to 2019” assumes home sales drop to the level in the same month in 2019 starting in May 2021. All series use a 3-month moving average to reduce noise.
Source: Fannie Mae Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

The Amherst Pierpont forecast is the most bullish, and results in the highest levels of net supply—an average of $100 billion a month for the rest of 2021. The Bloomberg scenario is slightly lower, averaging $93 billion a month for the rest of the year. But net supply will fall sharply if home sales were to fall to 2019 levels. Supply would average only $71 billion a month for the rest of the year and fall to roughly $30 billion a month by the end of the year.

The MBS market eventually may have trouble absorbing this level of supply. The Fed is currently adding $40 billion agency MBS each month to their balance sheet, and commercial banks so far this year have added an average of $52 billion a month. In the years preceding the pandemic, private investors typically absorbed between $20 billion and 25 billion of net supply each month. If the Fed begins to taper later this year and if bank appetite cools, too, then the TBA dollar roll may become less special and spreads would likely widen. Money managers would be the most likely investor group to step into the market in that scenario. They will have a lot of paper to absorb.

Brian Landy, CFA
brian.landy@santander.us
1 (646) 776-7795

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles