Despite the 10-year Treasury moving towards 4%, mortgages experienced strong buying throughout the week from real money investors - overseas, money managers, insurance companies - focused primarily in 5s and 5.5s. In addition, there was some early month-end buying ahead of the Memorial Day break. Lehman Brothers expects its MBS index to extend 0.10 years, on par with a 12-month average extension of 0.10 years and up from an average May extension of 0.09 years. Meanwhile, servicer participation was minimal and originator selling remained tame at its $1 billion per day average. Supply, however, is mostly in 5s at this time.
The tone in the market was much improved last week with the credit sector holding stable to better, and vol still relatively low. In addition, technicals are favorable, with limited supply while investors are sitting on plenty of idle cash. Longer term, the outlook for mortgages is looking less supportive. In fact, Lehman analysts describe the longer-term prospects for mortgages as "grim" due to full valuations, limited participation from the GSEs, and potential slowdown in the housing market. JPMorgan Securities also anticipates that over the next five to six months, mortgage OAS' will drift wider.
Mortgage application activity picks up
Mortgage application activity rose 4% overall, according to the Mortgage Bankers Association. Last week, the Purchase Index was up 3% to 482, and the Refinance Index gained 6% to 2168. In the same week, Countrywide Securities said it experienced an 11% jump in purchases and 10% in refinancings. As a percentage of total application activity, refinancings increased one percent to 40.3%. ARMs were also higher at 34.8% versus 33.9% in the previous report.
"Rates have declined 14 basis points over the last two weeks," said Jay Brinkmann, MBA vice president, research and economics department. "While the number of refinance applications increased 6.5% last week, the dollar volume increased by more than twice that amount, 13.5%, consistent with the idea that borrowers with larger balance loans respond quickly to even small rate incentives to refinance."
30-year mortgage rate at 5.65%
Freddie Mac reported a decline in mortgage rates in response to the earlier rally last week. For the week ending May 27, 30- and 15-year fixed mortgage rates fell six basis points to 5.65% and 5.21%, respectively; the 5/1 hybrid ARM rate was unchanged at 5.07%; and one-year ARMs averaged 4.21% versus 4.26% previously. "Release of the May Federal Open Market Committee minutes this week reinforced the notion that inflation in the economy in the first three months of the year was contained and upward price pressure in the near-term seems unlikely," noted Frank Nothaft, Freddie's chief economist. "And when inflation is contained, mortgage rates decline."
Looking ahead to this week's MBA mortgage application activity report, expectations are for the Refinance Index to hold near its current level.
Currently, the level seen as triggering a significant increase in prepayments and supply is a 3.85% 10-year Treasury yield, which corresponds to a 5.60% 30-year fixed mortgage rate, according to Bear Stearns. Countrywide Securities estimates fixed-to-fixed refinancings would not emerge until mortgage rates move through 5.5%, equivalent to roughly 3.75% on the 10-year.
As has been noted many times, refi response has become much more limited despite the existing rate levels. In research from Countrywide Securities, analysts attribute the lack of response to the large amount of payment-option ARMs being utilized as refinance vehicles. These loans are originated with teaser rates and a payment cap, and so higher rates "are expressed to the borrower in the form of greater negative amortization," noted Countrywide analysts, adding that borrowers who take out this type of loan with a relatively low LTV tend to be less sensitive to rate increases since it has not affected their payments yet.
At this time, the prepayment outlook has not changed much. May speeds are expected to be unchanged to slightly faster for 4.5s, 5s, and 2004 vintage 5.5s and 6s. Other coupons and vintages are expected to slow around 5% from April's levels. In June, speeds are predicted to increase around 10%, with July showing speeds to be down slightly.
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