Fed likely to reduce MBS portfolio by $9 billion in June, Deutsche says

The Federal Reserve‘s mortgage-backed securities portfolio will likely decrease 1% in June, a step in the right direction for reviving the nonagency mortgage-backed security market. Deutsche Bank said Wednesday it expects the Fed portfolio to decrease by $9 billion to a total $908.9 billion, marking the smallest monthly decrease since late last summer. Deutsche believes this will contribute to a 2011 yearly paydown of $166 billion. “This is a slight increase from February, when the projected one year paydown was $123 billion, but a decrease from the $345 billion estimated in November,” Deutsche said. The bank said 30-year loans at 4.5% interest rate are the most vulnerable for a prepayment spike, as prepayment speeds gradually increase. About 50%, or $450 billion, of the Fed’s MBS portfolio is concentrated in this slice. Deutsche Bank noted that a reduction in the Fed’s MBS portfolio may not be a terrible thing, as the agency is currently depressing any nonagency MBS performance and could send that performance even lower. In April, the Fed began selling $31 billion worth of subprime mortgage bonds through special vehicle Maiden Lane II. Deutsche Bank said the past and pending sales of these subprime credit put steady pressure on a market that generally traded between $1 billion and $2 billion a week before the Fed sales. “The Fed activity roughly doubled that volume, and much of the product is still reportedly sitting on broker/dealer balance sheets,” Deutsche said. “The market’s ability to absorb the Fed sales has eroded since the beginning of the program.” Write to Christine Ricciardi. Follow her on Twitter @HWnewbieCR.