As spreads for mortgage-backed securities reached their widest levels in three weeks, many market participants saw last week as an opportune time to buy.

"Things have picked up a little bit, I really get that sense," said one MBS trader. "Even though there is still pressure on, activity levels are picking up. Banks have been very active in buying short PACs and short whole loans. Banks are coming in, looking to invest money before quarter end. Banks want to carry a lot of liquidity over year-end because of Y2K, but any investments they want to make they want to make early, just like issuers."

While many investors saw a steady flow of residential MBS recently, they added that production is way down from where it was a couple of months ago - with the exception of the adjustable-rate mortgage market.

"There is more production of 5-1, 7-1, and 3-1 adjustable-rate mortgages," said Michael Hoeh, head portfolio manager at Dreyfus Corp. "As rates went up, the typical homebuyer looks at other options, so this makes sense. So Ginnie Mae ARM production went way up."

In fact, the ARM market has been one of the best performers of the year, sources say. Although last year there was a liquidity crunch in the ARM market, ARM indexes had a tremendous comeback so far this year, Hoeh added.

"ARMs have outperformed almost everything," Hoeh added.

The Lehman ARM index is up almost 3% year-to-date; by comparison, across all other products in the fixed income spectrum, indexes went down. The index for 30-year mortgages went down by 21 basis points, and the overall fixed income index went down by 1.7%.

"With an increase in supply, liquidity in ARMs will come back as well," said one MBS veteran.

As far as other relative values for last week, "collateralized mortgage obligations look fairly cheap," said another MBS trader. "Fifteen-year pass-throughs look cheap as well, and current coupon dwarfs look good, too. All jumbo issuance is going to ratchet down. Fifteen year products will be a refinancible product, so issuance in that will be very minimal, considering that refis are trailing off. CMOs are pegged to five-year sequentials, so a bunch of those bonds look good versus dwarfs, which in themselves are a good value."

Freddie Mac Prepayments Are In

Prepayments for Freddie Mac Gold premiums registered even larger drops in August on top of the sharp declines recorded last month, sources say.

"This should be received positively by MBS investors despite the marked volatility of MBS spreads," said Warren Xia vice president and prepayment specialist at Banc of America Securities. "Freddie August prepayments corresponded to the average mortgage rate at the 7.58% level."

According to Xia, September and October prepayment speeds are expected to trend down further. August prepayment speeds correspond to the mortgage rate, which is currently in the 8% area, so there is still some room for prepayments to decline.

"I'd say to expect a 10% to 15% decline in prepayments over the next two months," Xia added.

"For the October Fannie Mae report, we are looking for roughly 25% declines for the higher coupons," added Jonathan Raiff, prepayment specialist at Dreyfus Corp. "But there is still some uncertainty about how slow speeds will get or where they will bottom out.

"But we look for baseline speeds to be 15 to 20 percent faster than comparable rate levels in 1997," Raiff said.

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