Mortgage volume has been above normal in recent sessions, with Treasury yields trending lower and with the outlook for a full-blown recession gaining steam.
Influencing events in the first half of last week were a weaker-than-expected retail sales report for December, Citigroup's record loss of $9.83 billion in the fourth quarter, resulting from $18.1 billion in write-downs, and a lower-than-expected quarterly profit from JPMorgan following a $1.3 billion write-down. By midweek, the market was waiting to hear Merrill Lynch's fourth quarter results that came out on Thursday.
MBS flows were mostly supportive in the first two trading sessions last week. There was a wide range of investor participation from hedge funds, money managers and overseas buyers that were buying outright as well as versus Treasurys and swaps. Buying interest was focused on 5s and 6.5s. Real money investors' interest was concentrated in 5.5s through 6.5s, while leveraged and servicers were in 5s and even 4.5s. Reports from Street traders also noted an increase in pay-ups on specified loan balance Gold premiums resulting from buying by leveraged investors and CMO desks. GNMA/FNMA swaps were wider, partly as a result of increasing GNMA supply. If prices on GNMAs continue to rise, there is potential to see overseas investor selling. Through midday on Wednesday, mortgages were wider to the curve and swaps as supply and profit taking picked up and as buyers were less active.
Originator supply was limited at just $1 billion per day in the first half of the week and consisted of 5.5% and 5% coupons. Servicers held on to most of their supply from their origination business as rates moved lower.
Mortgages are off to a positive start in 2008. Lehman Brothers said that month-to-date through Jan. 11, the MBS Index has outperformed Treasurys by 21 basis points. This compares to 15 basis points for ABS, negative 34 basis points for CMBS and negative 78 basis points for corporates.
Mortgage Outlook
Currently, the Street's view on mortgages is mostly neutral. JPMorgan Securities analysts, for example, upgraded their view to neutral on the mortgage basis from negative the previous week. Some of the reasons for the shift were based on expectations that the Federal Reserve is becoming more aggressive based on Fed Chairman Ben Bernanke's recent speech as well as on improvement in market financing and liquidity. JPMorgan added that OASs are still near average levels, which keeps analysts from recommending an overweight. The firm's other concerns include expectations of increased originator supply and slower prepayments.
Lehman Brothers analysts do not think that the market has fully priced in the effects that tighter credit and negative HPA will have on speeds. JPMorgan analysts also said that many investors and servicers are using models that are too fast for the current environment. This raises the risk of duration selling on adjustments to the prepay models. There continues to be uncertain sponsorship as well, particularly from the banks and the GSEs.
The Street generally favors the up-in-coupon trades, as these securities appear cheap to lower coupons, which are perceived to be subject to both supply and extension risk related to model adjustments.
Refi Activity Surges
Mortgage application activity rose 28% in the week ending Jan. 11 based on gains in both refinancing and purchase activity. The 30-year mortgage rates tumbled 20 basis points to 5.87%, according to Freddie Mac's survey. The Mortgage Bankers Association reported that the Refinance Index soared 43.4% to 3575.5. This is the highest the index has been since the week ending April 2, 2004, when it was at 4127. A year ago, the index stood at 2046 with mortgage rates in the low 6.20% area. The Purchase Index jumped 11.4% to 461.2. By contrast, purchase activity was 440 a year ago.
As a percent of total applications, the refinancing share was 62.7%, compared with 57.7% previously. ARM share changed slightly at 9.2%, compared with 9.3% in the last survey. The refinance share is currently at its highest level since March 26, 2004.
Prepayment Outlook
Overall prepayment speeds are expected to be flat to slightly higher in January. Day count increases (21 days in January versus 20 days in December) should be offset by slower seasonals and limited borrower responsiveness to the lower mortgage rates.
Speed increases are expected to be confined primarily to 2007 and 2006 vintages, while older vintages will be slower versus December. For example, for FNMAs, speeds on 2007 vintages are projected to rise an average of nearly 9% for 5% through 6.5% coupons; over 4% for 2006 vintages; and by less than 3% for the older vintages. In GNMAs, 2007 vintages are projected to increase 15% on average; 6% for 2006; and less than 2% for older vintages.
Speeds are estimated to increase in February and March, with the largest rise found in 2007 and 2006 vintages.
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