Just when yields on mortgage-backed securities are shrinking to unpalatable levels, one of the premier prepayment forecasters has left Bear, Stearns & Co. to focus on expanding his aresenal of analytical tools.
Chuck Ramsey, a senior managing editor at Bear Stearns, officially joined Houston-based MMAR Group Inc. earlier this month. Mr. Ramsey founded "specified pool analytics," a method of distinguishing prepayment rates according to geographical and other data. He was also a full-time trader with Bear Stearns for over eight years.
The mortgage market has benefited directly from the trials in both the insurance and banking markets. Insurers, for example, are hustling to clean out suspicious corporate bonds from their portfolios, and mortgage-backed bonds -- even those at the high-risk end of the spectrum -- have enjoyed subsequent demand.
But yields have dropped. The spread of the 9% Government National Mortgage Association issue has narrowed to only 87 basis points over the 10-year Treasury. In late July, the spread had closed to 82, then it widened briefly, and has closed in again, according to Anatoly Burman, vice president at Mabon, Nugent & Co.
Prepayment analysis, always the key to avoiding ield losses, becomes even more important in this environment, analysts said, because the demand for yield is insatiable. The largest risk is the early retirement of the underlying loans -- or mortgage prepayment. And prepayments are Mr. Ramsey's specialty.
At MMAR Group, Mr. Ramsey will be a managing partner and assemble a small New York sales force to concentrate on mortgage-backeds. He will also focus on expanding MMAR's London activities.
Despite the rising tide of institutional funds flowing into the mortgage-backed area, Mr. Ramsey thinks the trend -- particularly the insurance industry's liquidation of corporates and some municipals -- is temporary.
"You have a corporate market with a lot of risk in it, and in the municipal bond market, you can't even get a bid on certain issues," he said. "People are getting paranoid about corporates; there's not a whole lot of value added in terms of spreads.
"But this is not unusual, it normally settles down after a while," Mr. Ramsey said. "I don't think we'll see the continuation of the insurance sector troubles. They have been notorious for gobbling each other up, so that could correct some of the problems."
The insurance company portfolio managers are looking into mortgage-backed derivative securities that had fallen into disfavor after many accounts were burned several years ago, Mr. Ramsey said. Senior subordinated debt structures, inverse floaters, and residuals, for example, all are enjoying strong institutional demand, and this trend is unlikely to abate soon.
"I see a clear movement at insurance companies," he said. "Rather than take interest-rate risk, they are taking the credit risk of the underlying mortgages. And derivatives, particularly inverse floaters, are becoming more common because they understand them more than they did before."
Mr. Burman of Mabon Nugent attributed the insurance company buying to the regulatory environment. Concern that Congress will attempt to impose some sort of investment criteria on the insurers, since problems in the investment portfolios at Executive Life Insurance Co. and Mutual Benefit Life Insurance Co. led to conservatorship, is sparking corporate bond selling, he said.
The supply outlook for most mortgage-backed obligations is fairly thin, according to both Mr. Ramsey and Mr. Burman. "The flood of supply is over," Mr. Burman said. "You'll see less collateral, so spreads are not expected to widen."
Mr. Ramsey said housing starts will not see "a lot of change," with interest rates remaining flat to slightly lower. Mortgage issuance "will remain within tight bands," he said, because homebuying drops off as the summer ends.
People have not changed over the years, he maintained, and still do most of their moving and purchasing when the kids are on summer vacation. Consequently, prepayment risk also drops off in the fall.
Mr. Ramsey's move to MMAR will be followed by the use of additional analytical techniques currently being assembled, although he declined to specify the new methodology.
Yesterday's Markets.
Moody's Investors Service yesterday released a report that predicted high-yield corporate bonds would end 1991 with record defaults. The agency said the junk market is cruising toward an 11.5% default rate, which would exceed 1990's 8.8% level and surpass even the post-World War II high of 10.9% in 1970.
Moody's economist Jerome S. Fons arrived at the default rate through a statistical model described in the report, A Simple Approach to Forecasting Default Rates.
The report was greeted as "last year's news" by corporate bond participants, who noted that prices of most high-yield issues were unchanged to 1/4-point higher, affected neither by the report nor the escalating Treasury market.
Mark Derbiano, portfolio manager at Pittsburgh-based Federated Investors Corp., said actual default rates are less helpful than examining trading values in relation to defaults.
"People who play up the default side forget that the game is to maximize value," Mr. Derbiano said. "While they're right, and you'll probably have 10% to 11% defaults this year, it's an incomplete analysis to say that alone is a major negative.
"The market was so depressed at the end of the year," he added, "the average mutual fund can be up 20% to 25% this year already."
In the investment-grade market, continuing supply began to take a toll on spreads, with prices unable to keep pace with the Treasury market's robust showing. So far this week, $1.53 billion has been sold.
The $200 million Seagrams & Sons Inc. 30-year 9s, for example, widened to 95 basis points over the 10-year Treasuries from Tuesday's pricing at 87 basis points over, according to traders.
New-issue activity included a $200 million 10-year sale by Imperial Oil. The high-quality bonds, rated AAA by Standard & Poor's Corp. and Aa1 by Moody's, were priced by J.P. Morgan & Co. at 41 basis points over comparable Treasuries to yield 8.33%.
Other new issues were a $150 million Alcan Aluminum Ltd. five-year note offering, which Morgan Stanley & Co. priced at 78 basis points over Treasuries for an 8.22% yield, and a $100 million five-year note sale by Easton Corp., priced by Goldman Sachs & Co. at 100 basis points over Treasuries.
