April was the highest prepayment month on record. According to JPMorgan Securities fixed-rate agency paydowns hit nearly $160 billion, a 16% increase over March. The paydowns have led to an $18 billion decline in outstanding fixed-rated collateral. In addition, JPMorgan reports that net issuance in 30-year paper was negative $27 billion - the largest one-month decline on record.
In the April prepayment reports, speeds on unseasoned and lightly seasoned Fannie Mae 6s and 6.5s generally came in faster than consensus was predicting. For example, 2002 6s prepaid at 49% CPR versus expectations of 47%, and 2001 issues prepaid at 64% CPR versus 62%. In 6.5s, 2002 vintages prepaid at 63% CPR versus 62%, and 2001 vintages at 72% CPR versus expectations of 71%. Other coupons and vintages prepaid at or lower than consensus was forecasting.
Meanwhile, 2002 Gold speeds were faster than Fannies in 5.5s, 6s and 6.5s. Bear Stearns suggests this is tied to two factors: (1) heavy concentration of Wells Fargo loans; and (2) the shorter refinancing aging ramp associated with ABN Amro pools.
The big surprise in the prepayment report, according to JPMorgan, was the acceleration in 15-year speeds. The firm reported that 2002 Dwarf 5s prepaid at 27% CPR, an increase of 73% from March; and 5.5s prepaid at 50% CPR, a gain of 39%. This suggests that new production 15-year paper may not offer the prepayment protection that has been expected from 15-year paper, says JPMorgan.
On the other hand, Ginnie Mae speeds increased less than estimated by consensus. For example, 2002 5.5s prepaid at 12% CPR versus expectations of 16% CPR; 2002 6s at 39% CPR versus 44%; 2002 6.5s at 57% versus 60%; and 2002 7s at 58% CPR versus 63% CPR. UBS Warburg attributes the weaker increases versus conventionals to less focus on FHA/VA loans during peak refi periods. Analysts generally expected speeds on Ginnies to peak in the April report. The limited increase relative to Fannies suggests May could see further increases.
Bear Stearns says that with last week's rally to a 5.60% mortgage rate, over 84% of the agency fixed-rate universe is exposed to a refinancing incentive of at least 40 basis points. This represents $2.44 trillion fixed rate pools. Looking ahead to May, JPMorgan expects speeds to accelerate 15% from April's levels. At this time, the street is expecting speeds to start declining in June; however, the decline is likely to be limited due to lender backlogs that have pushed closings back. In addition, rates are back near record lows, which has popped refi applications back up to the 6000 level. If primary mortgage rates fall another 10 to 15 basis points, says JPMorgan, the Refi Index could break its 9387 record set for the week ending March 14.
As rates moved back towards March's record lows, mortgage application activity picked up as was expected. The Purchase Index gained 17% to 416, which is a new record high. The previous record was 414 hit May 31, 2002. Meanwhile, the Refi Index rose 19% to 6078. As a percentage of total applications, refinancing activity was little changed at 68.7% from 68.4%. The share of ARM activity fell to 13.1% from 14.3% in the previous report.
Mortgage rates dropped more than analysts were expecting for the week ending May 9. According to Freddie Mac, the 30-year fixed rate mortgage rate fell to 5.62% from 5.70%. This is just one basis point above March's record low. The 15-year rate fell six basis points to 4.97%, and is just four basis points above its March low. Lastly, the one-year ARM rate did set a new record low at 3.66%, falling from 3.74%.
These levels should stimulate refinancing activity. Analysts currently are predicting a print of between 7000 and 8000. JPMorgan says that secondary mortgage prices suggest a potential breakout to a 9000 level in the Refi Index over the next couple of weeks. The reversal in the Index and expectations of further gains suggest that speeds may not slow in June, but could hold flat instead.
FOMC ease bias encourages down in coupon buying
Last week started off slowly on the wait for Tuesday's FOMC announcement, but that quickly changed following the announcement. Activity was concentrated primarily in down in coupon moves to 30-year 5s and 15-year 4.5s. One trader noted that 5s are viewed as the last liquid coupon with any kind of duration. At the same time, there was heavy buying in 10-year Treasurys as investors added duration. Over the Wednesday-to-Wednesday period, spreads generally held within a narrow range.
Overall, the Street is weighted more towards neutral on the MBS sector, though overweights are recommended for current coupons. Areas in the sector that are causing concern to Lehman Brothers are: (1) increased call risk with mortgage rates back down; and (2) the magnitude of vega coming into the market from Index restriking. Credit Suisse First Boston adds there is risk of sympathy widening in mortgage spreads to Treasurys on the potential for swaps to weaken from their record tight levels.
On the positive side, there is the declining net issuance and strong rolls. CSFB expects 30-year net issuance to remain negative over the next three months. At the same time, there continues to be strong demand from banks, index managers, and the GSEs in the lower coupons.
On the roll front, JPMorgan cautions that while the float in FNMA 5.5s net of CMOs seems substantial, it may be precariously low in light of the magnitude of bank and GSE purchases. The firm notes the roll is already at fail for May/June. Regarding FNMA 6s, they recommend investors roll early as dealers are unlikely to want to be long the 6 roll on 48-hour day. The 48-hour notification begins next Monday for 30-year conventionals.
On the vol front, traders have noted a significant pickup in buying from mortgage accounts in recent weeks as vols are at two year lows. Of particular note is that the buying has been concentrated in three- to five-year expirations versus six-months to one-year as it has been in the past. One possible reason for this is concern about the increase in vega needs of the mortgage index.