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Outlook for near-term issuance dims in 'somewhat fractured' RMBS market

Asuccessor transaction to the December 2015 prime jumbo mortgage securitizationsponsored by Hatteras FinancialCorp.'s residential mortgage conduit could be a while coming inlight of challenging RMBS market conditions.

Themortgage REIT had already cautioned in February about the potential for alonger lead time for the next deal on the fledgling Onslow Bay Mortgage LoanTrust platform. Annaly CapitalManagement Inc., in conjunction with its recent announcement of itsagreement toacquire Hatteras for $1.50 billion, signaled the likelihood that it wouldemploy a different approach for funding the residential mortgage strategy atleast in the near term.

"Theclear synergy here is our ability to finance the existing [residentialwhole-loan] portfolio with the FHLB at very attractive rates," DavidFinkelstein, chief investment officer, agency and RMBS at Annaly, said duringan April 11 conference call, according to a transcript of his remarks.

Hatterashad cautioned during its fourth-quarter 2015 earnings call in February that it would likely have toresort to "relatively expensive" warehouse financing for theresidential whole loans following the Federal Housing Finance Agency's Januaryissuance of a final rule governing membership in the federal home loan banksystem by captive insurance companies.

Sincethe Diamond Shoals Insurance Co. LLC subsidiary of Hatteras had become part ofthe Federal Home Loan Bank ofAtlanta after the FHFA had issued its notice of proposed rulemakingin September 2014, its membership is due to terminate in February 2017. Annaly's Truman InsuranceCo. LLC unit had joined the FederalHome Loan Bank of Des Moines prior to September 2014, so itsmembership would not sunset until February 2021 under the terms of the finalrule.

"TheFHLB provides a very strong alternative to financing residential credit,"Finkelstein said.

ThroughOnslow Bay Financial LLC, Hatteras acquires prime, nonconforming whole mortgageloans from select originators and secondary market participants with the intentto engage in securitization. Hatteras plans to hold onto the subordinatedsecurities associated with Onslow Bay securitizations and portions of theAAA-rated tranches, and the mortgage REIT reported in its latest that it retainedapproximately 75% of the beneficial interests issued by Onslow Bay MortgageLoan Trust 2015-1.

HatterasChairman and CEO Michael Hough reported during the February call that newcommitments for the purchase of jumbo adjustable-rate mortgages had"fallen significantly over the past few months" as a result offactors such as flattening in the yield curve and banks' retention of theirproduction.

"Weremain steadfast in our return targets and credit standards and will not raiseprices or lower the credit box in order to chase higher mortgage volume. Thatmakes no sense," he said. "So lower volume means a longer perioduntil we could complete our next securitization and get the leverage we desire."

Finkelsteinsaid during the deal call that Annaly shares Hatteras' view that whole-loanpricing remains competitive and that market pricing "is not currentlyconducive to securitizations." Later, in response to an analyst's questionon the topic, he paraphrased what he said to be the opinion of Hatteras'management that the whole-loan origination and securitization market "issomewhat fractured for the time being."

Atthe same time, he added, "This remains an option for us, and favorablefinancing provides us the flexibility to remain patient." Finkelstein saidAnnaly anticipates "evaluating every option that comes forward with respectto loan origination."

Thetwo mortgage REITs have company in their relatively pessimistic views ofnear-term market conditions for the issuance of RMBS.

Standard& Poor's Ratings Services recently dialed back its full-year 2016 outlookfor U.S. RMBS-related deal activity to $50 billion from $70 billion afterfirst-quarter issuance slumped to approximately $7 billion from $15 billion inthe year-earlier period. S&P Ratings, which like S&P Global MarketIntelligence is owned by McGraw Hill Financial, includes prime jumbo,reperforming, nonperforming, credit risk transfer, single-family rental andservicer advance transactions within the RMBS-related bucket.

S&PRatings said it lowered the forecast even though it does "expect somepickup in activity amid efforts to revive the private-label market."

Sponsorsof prime jumbo RMBS during the first quarter included 'sWinWater Home Mortgage LLC and Two Harbors Investment Corp. Others pastissuers, notably including RedwoodTrust Inc. and FiveOaks Investment Corp., appeared to have remained on the sidelinesduring the period.

"Recently,it's been difficult to transact attractively in the space because of thewidening of AAA spreads," Redwood Trust CEO Martin Hughes said during aMarch 16 panel discussion at an investor conference in which he listed the lackof liquidity as the single biggest impediment to the market's reopening."Having said that, we still maintain and in the fullness of time, webelieve private-label MBS represents an attractive investment class, and weremain committed to our Sequoia programs to producing the best quality and thebest performance."

AddedTwo Harbors Chief Investment Officer William Roth during the same paneldiscussion: "I think everybody in this room knows thatsecuritization market has been very slow to reopen. But that being said, thereis a lot of optionality to that business to the extent that the banks' lust formortgages on their balance sheet changes in different rate environments. Theability for us to grow that business dramatically is there."