The mortgage-backed securities sector became ‘too cheap too quickly’ after President Barack Obama’s re-election. As a result, the selloff provided a good entry point for investors, according to a report by Bank of America Merrill Lynch (BAC).

The analysts stopped short of saying the activity in the mortgage bond market is directly correlated to the presidential election.

As mortgage rates for mortgage banks continue to remain low concerns about prepayment rates are valid. As a result, building out capacity to refinance premium mortgage borrowers still available is the best solution, analysts said.

The MBS Index Option-Adjusted Spread was 52 basis points wider in October compared to negative 12 in September.

Click on the graph below to view the Merrill Lynch Mortgage Index OAS. 

Generally, this would indicate that markets have taken a sharp turn too quickly because of the development of significant information. However, the analysts said that this was not the case for the MBS market and that fear of the risk of prepayment rates got the best of investors.

"Rather than making high drama moves, it appears to us that Washington wants to refinance borrowers the 'old-fashioned way': Keep mortgage rates low and give the mortgage banking industry time to go out and find and take advantage of the many profitable refinancing opportunities that currently exist," the report said.

The weakening in the agency MBS market was due to three factors: elevated prepayment risk, the implementation of debt forgiveness and refinancing programs for government-sponsored enterprises mortgages, and supply pressures from increases in g-fees from Freddie Mac and Fannie Mae. 

However, concerns outweighed the reality. 

The Home Affordable Refinance Program's October report stated that cohort speeds remained high. There also is a low probability of a large-scale debt forgiveness scenario as the market has highly mispriced the risk. Also, supply pressures for g-fees will subside after Dec. 1, since there was a pull-forward of supply to beat the deadline.