MBS volume was running below normal through the middle of last week as a result of mixed flows. A strong early rally on Tuesday, along with weaker rolls, led to MBS selling by money managers and banks. However, the substantial widening was mostly recovered by the end of the day as fast and real money took advantage of the cheapening. Overseas investors were mixed early in the week, with some buying limited by a series of Asian holidays. One sector that saw increased interest was specified pools, particularly 5s and 5.5s.
Better interest in MBS was anticipated on month-end buying, especially from overseas, toward the end of the week. Lehman Brothers expects the MBS Index to lengthen 0.06 years, which is substantially lower than the September average, but this still translates to a month-over-month increase of 0.02 years in overall duration, to 3.81 years. Meanwhile, the Aggregate Index is forecast to extend 0.08 years, primarily due to a 0.12-year move out in the Agency Index.
Originator selling was running at about $1.5 billion per day, on average. Supply focused primarily in the 6% coupon.
MBS traders looked to close September on a positive note, though substantially off midmonth gains. For the month through Sept. 25, Lehman's MBS Index had outperformed by 26 basis points. This is down from 70 basis points in excess return on Sept. 19. MBS are no longer the leader of the pack, either, with CMBS finally gaining the lead at 39 basis points over as of last Tuesday. The ABS Index offered 24 basis points in excess return, with the Corporate Index at 19 basis points in excess return.
Housing Data Stay Discouraging
Data releases continued to point to a weak housing market. For example, the Standard & Poor's Case-Shiller Home Price Index fell 0.45% from June to July and 3.91% between July 2006 and July 2007. Meanwhile, existing home sales fell 4.3% to a 5.50 million rate, better than the consensus call of 5.445 million. However, the inventory of unsold homes rose to a 10-month supply - a 19.5-year high. Apparently, home prices haven't declined enough to entice buyers. In fact, the median home price was up 0.2% from August 2006 to August 2007, the first year-on-year increase in 13 months.
Prepayment speeds were also seen slowing on deals. UBS analysts said they expect to see significant slowing in speeds in the coming months as the full impact of the subprime market shutdown in August becomes tangible. In addition, there is traditional seasonal slowing in the fall and winter months, along with a large number of loans expected to reset. "The triple witch of reset, market shutdown and negative HPA foretells a long and dark road ahead," UBS analysts said.
Mortgage Outlook
The September prepayment reports will be out on Thursday evening for conventionals and Friday morning for GNMAs. Speeds in September are expected to slow around 15% to 20%. The decline comes primarily on a drop in the number of collection days to 19 from 23 in August. At the same time, mortgage rates were lower at 6.57%, on average, in August versus 6.70% in July, which stimulated refinancing activity based on results of the Refinance Index. Paydowns are estimated to be in the low $30 billion area. Speeds recover in October as day count increases and holds steady in November.
The longer-term outlook, however, is less positive due to expectations of heavy Agency supply - coming in part from GNMAs, through the FHASecure program, and possibly higher conforming loan limits. In research from JPMorgan Securties last week, analysts said they were holding a negative view on the mortgage/swap basis. Reasons included increased supply related to potential legislation on FHA and conforming loan balance increases, as well as from deleveraging. They added that volatility could be pushed higher, as well, if investors hedge their volatility exposure. Another point they make is that higher loan limits, if they pass, could cause the convexity of TBA mortgages to worsen, thus pressuring spreads.
Purchase Activity Slides, Refis Gain
As expected, overall mortgage application activity declined for the week ended Sept. 21 as mortgage rates increased. However, the decline was due to a slowing in purchase activity rather than refinancings. For that week, Countrywide Securities said it actually experienced a 6% slowing in refinancings.
The Purchase Index dropped 7.3% to 418.8, its lowest level since late July, while the Refinance Index gained 3.3% to 2026.5, as reported by the Mortgage Bankers Association. This is the fourth straight week of gains - and the highest the Refinance Index has been since mid-May.
The MBA also reported a nine basis-point increase in the 30-year fixed contract rate, to 6.38%, while one-year ARMs tumbled 30 basis points to 6.09%. As a percent of total applications, the refinance share rose to 46.4% from 43.5%. ARM share slipped to 12.2% from 12.6%.
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