Mortgage activity picked up around midweek as a wide range of investors took advantage of the recent cheapening and generally benign economic news. Support strengthened further Thursday on month-end index buying, and squaring of positions ahead of last Friday's March employment report. At the same time, originator selling remained average at around $1 billion per day.
Analysts last week were mostly neutral to modestly overweight the sector. Lehman Brothers, which has been underweight for quite some time, turned neutral on mortgages. Analysts believe that with the "normalization" of rates, mortgages could benefit from the carry trade returning. Steady demand from banks, increased support from indexed accounts and lower selling risk from the GSEs are also supportive of mortgages. Regarding banks, analysts note that deposit growth remains high, while C&I lending remains a non-issue. With rates returning to more normal levels, Lehman also anticipates better demand from index accounts as they cover shorts.
Finally, over the near term, analysts believe the limited demand from the GSEs is not worrisome. Fannie Mae is not expected to aggressively sell mortgages out of their portfolio and, at the same time, Freddie Mac appears willing to take advantage of cheapening opportunities. UBS noted that Freddie clearly took advantage of late February's cheapening to increase its mortgage holdings by an annualized 13.4%. "This suggests that Freddie is ready, willing and able to buy on any cheapening, and is very opportunistic," UBS analysts wrote.
MBA Purchase Index increases 5.5%
The Mortgage Bankers Association reported a slight increase in mortgage application activity as a result of purchases. For the week ending March 25, the Purchase Index rose 5.5% to 471, while the Refinance Index slipped 2% to 1857. As a percentage of total application activity, refinancings declined to 37.8% versus 39.5% in the previous week, while ARM share rose to 36.6% from 33.5%. Mike Cevarr, the MBA's director of industry surveys, said, "Rates on 30-year fixed-rate mortgages have increased 34 basis points over the last month. Following this increase, the market attained a record high ARM share this week, both in terms of number of loans and dollar volumes."
JPMorgan Securities noted that ARMs are primarily a purchase product. Given the increase in home price appreciation and the need for borrowers to keep payments affordable, JPMorgan expects the ARM share to remain high despite a flatter yield curve (see related story p. 19).
Fixed mortgage rates up slightly
Fixed-mortgage rates increased slightly, as was expected for the week ending last Friday. Freddie Mac's survey reported that the 30-year, fixed mortgage rate increased three basis points to 6.04%. Meanwhile, 30-year rates are at their highest level of the year, but still well below last year's 6.34% high hit in mid-May. Looking ahead to this week's mortgage application activity, analysts expect the Refinance Index will hold steady around the 1800 area, assuming rates remain near current levels.
The survey also reported 15-year fixed rate mortgage rates averaged 5.58%, up just two basis points from the previous week. Meanwhile, 5/1 hybrid ARM rates rose to 5.43% from 5.35%; and the one-year ARM rate reported in at 4.33% versus 4.24% previously.
March prepay outlook
The March prepayment report will be released on Wednesday. Prepayments are expected to jump around 25% for most Fannie coupons, though 5.5% coupons are predicted to be up 30%. GNMAs are anticipated to increase around 15% with 5.5s 20% higher from February. The surge is the result of the decline in mortgage rates in February and an increased day count. Freddie Mac stated that the 30-year mortgage rate averaged 5.63% in February, versus 5.71% in January, and 5.75% in December. The March day count is 22.5 days, versus 19.5 days in February.
In April, prepayments are expected to decline from 10% to 15% for both FNMAs and GNMAs. The decline is a result of gains in mortgage rates and a lower 21-day count. Similar percentage declines are currently predicted for May at this time.
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