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Wells Fargo: MBS Extension Risk ‘Far More Severe’ Than Models Suggest

This is a syndicated repost courtesy of Confounded Interest. To view original, click here. Reposted with permission.

The pony people (aka Wells Fargo) has just issued a mortgage-backed securities alert.

Now The Balance Begins To Shift

The balance between QE and Treasury supply will begin to shift in July. The underlying bid it has provided for stocks and Treasuries will begin to fade.

This report tells why, and what to look for in the data and the markets.  GO TO THE POST

(Bloomberg) — Extension risk in mortgages is “far more severe” than production coupon models suggest, Wells Fargo managing director on the mortgage trading desk Kevin Jackson wrote in a client note.

Investors need to ask themselves how they feel “about current compensation for extension risk”

Interest rates moving higher make it “far more difficult” to model and assess turnover, first time borrower demand and trade up/trade down propensity

Convexity/gamma “adds an additional layer of pain to extension” as higher levels of implied interest rate vol suggests higher levels of extension

Recommend adding new origination and select seasoned cash flows as defense against implied interest rate vol

Yes, 30-year mortgage rates are rising, and rising faster than the benchmark 10-year Treasury yield.


Extension risk occurs when securities with call or prepayment options (like MBS) delay their expected call dates or prepayment speeds and effectively extend the expected maturity or duration. And rising interest rates (like today) leads to rising duration and convexity on MBS.


The Wells Fargo wagon is delivering higher MBS duration and convexity. Hedge accordingly!


Wall Street Examiner Disclosure: Lee Adler, The Wall Street Examiner reposts third party content with the permission of the publisher. The opinions expressed in these reposts are not those of the Wall Street Examiner or Lee Adler, unless authored by me, under my byline. I curate posts here on the basis of whether they represent an interesting and logical point of view, that may or may not agree with my own views. Some of the content includes the original publisher's promotional messages. No endorsement of such content is either expressed or implied by posting the content. All items published here are matters of information and opinion, and are neither intended as, nor should you construe it as, individual investment advice. Do your own due diligence when considering the offerings of information providers, or considering any investment.

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