ABS

Analysts developed a methodology for auto residual analysis and discussed a framework in a recent report. Auto residuals offer equity-like returns for qualified investors eligible to participate in the sector. The firm's analysis built in 16% to 22% returns. Actual investment returns could differ based upon deviations from expected prepayments and defaults, including possible loss of principal. All of the residuals returned positive results under the stressful scenarios analysts modeled, and as described more fully in the firm's next report. Discussion of auto residuals in the currently dislocated credit markets might seem misplaced, but when more stability returns to the markets, an auto residual market will have attractive potential. Because the industry is restructuring and seeking new ways to raise capital efficiently, analysts believe auto residual issuance could grow in importance. Up until now, manufacturers have not tapped the residual market to any great extent. Intex is useful in stressing seasoned transactions, which should greatly facilitate market transparency and remove the "black box" aura that surrounds residuals in other markets. April 4, 2008

The ABS market has rallied smartly over the past week as new legislative proposals and a broader investor base have helped buoy a beaten down market. The fundamental value of many of the cashflows looks very compelling especially relative to other sectors in the market but techincals still appear quite daunting. The good news is that most of the real money selling in the U.S. seems to be behind the market and the Fed seems to have stabilized financing issues, which may, in turn, help stabilize the repo markets for levered players. Furthermore, the investor base is expanding. Analysts still would rather pay up for certainty, focusing on front pay, 2nd pay, and seasoned cashflows. But there does seem to be a light at the end of the tunnel, finally, in the ABS market. April 4, 2008

The downside risk for ABX prices is that some “watered down” alternative to Barney Frank (Dem-Mass.) and Chris Dodd's (Dem-Conn.) initial proposals is ultimately passed, or investors lose confidence that something will get done. Higher rated ABX rallied by three to nine points over the past two weeks, with the biggest upside going to the at-the- money tranche, (i.e., the tranche whose hard enhancement plus excess spread is closest to the expected loss on the pool). The student loan sector's liquidity issues have clearly reached a crisis mode that could limit the availability of loans to students, and already threatens the ongoing viability of FFELP lenders. Liquidity support was sought on two fronts: 1) ASF and SIFMA solicited eligibility of triple-A FFELP and private student loan ABS for the term securities liquidity facility from the Fed, and 2) a new bill from Senator Edward Kennedy (Dem-Mass.) that would allow the government to purchase loan collateral directly from lenders. April 4, 2008

In terms of security valuation as seen through Barney Frank (Dem-Mass.) and Chris Dodd's (Dem-Conn.) proposed plan, analysts recommend a credit steepener trade. Super senior/front -end triple-A yields should benefit from faster speeds as these securities are currently trading at significant discounts. Credit IOs are likely to be negatively impacted due to front-ending of losses. April 7, 2008

Analysts contend that, by their nature, ABS CDS and the ABX are inferior “housing market shorts.” First, the structural protections (credit enhancement) provide sufficient protection against defaults related to home price declines. Second, there are contracts referencing the Standard and Poor’s Case Schiller Indexes trading on the Chicago Mercantile Exchange. In addition, homebuilder stocks are a more direct short of the housing market. Analysts believe an initial and maintenance margin equal to the greater of 30% or the upfront would go a long way to restoring the CDS market to its originally stated purpose as a means of insurance against defaults rather than as a speculative market requiring little or not capital. April 4, 2008

CMBS

Analysts do not recommend that investors get too far ahead of themselves in anticipating a quick recovery, as they expect continuing issues in the floating-rate markets. In the past , analysts have highlighted this subproduct as a weak link in commercial properties, as aggressive underwriting parameters on floating-rate mortgages have created a subsector that will see more than its share of defaults. As those issues happen, they will continue to support volatile and technical trading in the fixed-rate market. But now analysts believe the fixed-rate market has started to adopt a more muted response to negative events that should be viewed as a relatively unrelated market sector. Thus, with the recent better market tone, analysts regard any weakening movement in spreads as a fixed-rate buying opportunity. They said this mostly because the real estate and commercial mortgage fundamentals have remained more stable than they expected during this past period, while credit performance has simply reflected natural seasoning. April 4, 2008

The CMBS market will probably rally or widen in sympathy with tightening in ABS and MBS markets. The impact of government action/policy change, however, should realistically only provide true benefit for 2006 to 2007 vintage CMBS bonds at the top of the capital structure, where analysts attribute much of the spread widening to technical factors. With this in mind, from a technical trading perspective, it appears that short covering has run its course and analysts would look to re-enter short-risk trades on the CMBX.2 and 3 at the double-A through triple-B minus levels. April 9, 2008

MBS

Analysts propose a framework to create efficient portfolios to take advantage of spread recovery across the mortgage market. Taking into account bid/ask, carry and potential tightening, analysts highlight Alt-A and agency hybrids as the most attractive sectors. In particular, the Alt-A sector now offers equity-like returns without incorporating leverage, and should begin to attract new capital. Analysts review mortgage insurers' risk and loss outlook. Despite historically wide spreads, stay close to home on the mortgage / swap basis. Buy agency hybrids: ROEs exceeding 30% should attract agency and leveraged sponsorship. Stay up-in-coupon. Buy 15-years owing to better convexity and wide OAS / ROE versus 30-years. Buy high LTV collateral in specified pool or inverse IO form. Buy well-structured senior tranches off Alt-A, which can provide double-digit yields and excellent carry. April 4, 2008

It is hard to justify being short the basis amid continuing uncertainty surrounding regulatory measures. Although the considerable agency MBS supply overhang remains for the time being, the market picture could easily improve, depending on the timing and magnitude of capital relief for market participants. Analysts do not recommend an overweight stance on the sector, as the ultimate source of demand for $600 billion of supply still remains in question. The recommendation that analysts have had the most conviction on this year is to own up-in-coupons in the stack. The firm's recommendation to buy FNMA 7s versus FNMA 6s has had a good run this week, with the trade posting about 5/32nds in excess returns last week. The up-in-coupon trade has done particularly well despite the curve flattening by about 10 basis points. Analysts continue to like owning up-in-coupons in the form of FNMA 7s and 6.5s versus FNMA 6s and 5s, respectively. Analysts also continue to recommend an overweight to hybrids over fixed-rates. April 7, 2008

Since the wide in MBS spreads in early March, the MBS market has made a substantial recovery. The recovery has been lead by the most liquid and tradeable sector of the MBS market, 30-year TBA passthroughs. However, with TBA collateral trading so well, other sectors of the MBS market have cheapened relative to TBAs. April 8,2008

Analysts remain neutral on the mortgage basis. With the tightening, the no-points mortgage rate is now 5.93%. Refinance activity will pick up dramatically if rates decline another 20 to 30 basis points. In particular, there will be sharp acceleration in prepayments on non-credit-constrained agency passthroughs, while credit-constrained paper will prepay moderately. With this in mind, analysts looked at value in non-TBA eligible collateral: 10/20 IO products, 40-year product, and the new GNMA II Jumbo pools, and find 10/20 IOs are the most attractive. Short agency cash flows When the curve steepened, spreads on short agency MBS (15-year, short CMOs, hybrid ARMs) widened more than on longer counterparts, as absolute yield buyers dominated. Then, these past few weeks, the yield curve flattened, and agency MBS with short cash flows have not done well (there's been some selling in these sectors). Thus, short agency MBS are extremely attractive to longer paper. In particular,15-year passthroughs are cheap to 30-year; short CMOs & hybrid ARMs are even cheaper. April 8,2008

CDO

Corporate products extended their gains. CLOs did not participate in the rally. Analysts remain cautious given the decimated investor base and reiterate their underweight. However, investors may wish to begin dollar-cost averaging into attractive positions. Issuance is likely to slow with cash loans gaining to $89. Analysts estimate SF CDO upside potential in a housing bailout by looking at average collateral composition (sector, rating and vintage) and capital structures. Mezz senior triple-As could be impaired by $7-8 due to reduced IO values of triple-B-rated HEL. Senior triple-A investors in high grade transactions may gain $4-7 on average. Gains are limited by exposure to risky securities such as SF CDOs, double-A and single-A rated HEL, and Alt-A bonds, but exposures differ materially across CDOs. April 4, 2008