Mortgages are off to a strong start in August. For the month through Aug. 7, the Lehman Brothers MBS Index outperformed Treasurys by 30 basis points. In fact, MBS is outperforming ABS (six basis points over), CMBS (negative 40 basis points) as well as corporates (negative three basis points).
The improved performance came on a break in the flight to quality that allowed volatility to decline and swap spreads to tighten. This encouraged active buying from real-money investors that was focused primarily in 5.5% and 6% coupons. Originator selling averaged more than $1.5 billion per day, with supply largely in 6s and to a lesser extent in 6.5s.
Contributing to the mortgage market's improved tone last week were reports that the Office of Federal Housing Enterprise Oversight might lift the GSE portfolio caps to allow the agencies to help support/stabilize the market in light of the subprime and credit turmoil (see story next page).
Several key economic releases are scheduled for this week, kicking off with Business Inventories and Retail Sales on Monday; International Trade and PPI on Tuesday; CPI, the Empire State Manufacturing Survey, and Industrial Production on Wednesday; Initial Claims, Housing Starts and the Philly Fed Survey on Thursday; and the preliminary Michigan Sentiment Reading on Friday.
In the mortgage realm, 48-hour notification begins on Thursday for Class B (15-year MBS), and on Friday for Class C (30-year GNMAs).
MBS performance remains subject to events in the subprime market. When subprime news is quiet, mortgages tend to strengthen and then lag as the bad news hits. Once the negative headlines quiet down, however, mortgage-backeds are expected to outperform as investors take advantage of the sector's cheapening.
Prepayment speeds declined slightly more than expected overall in July for 30-year FNMAs in response to the jump in mortgage rates. The 30-year fixed mortgage rates averaged 40 basis points higher in June versus May, while the Refinance Index was 12% lower, on average. Day count was unchanged at 21 days.
In particular, 5% coupons slowed around 10% to 12% versus a consensus of 7%. The 6.5s were also slower than expected, while the belly of the stack was more in line with forecasts. FHLMC Golds slowed slightly less than FNMAs and were in line with expectations, with the exception of 6.5s, which were also slower than anticipated. Meanwhile, GNMAs did not slow as much as expected: 3% overall versus a previous expectation of 10% slowing.
JPMorgan Securities analysts reported that overall fixed-rate agency paydowns totaled $36 billion, down 11% in July. Net fixed-rate issuance in 30s was approximately $43 billion, while 15-year MBS declined by $4.7 billion.
Prepayment speeds are expected to increase slightly in the August report as a result of a two-day increase in the number of collection days. In July, the 30-year fixed mortgage rate averaged 6.7%, versus 6.66% in June. The Refinance Index averaged 1693 in July, down nearly 4% from June's average. Prepayment speeds are currently expected to decline 15% to 20% in September as the day count declines to 19 from 23, along with the traditional slowing in turnover with the start of fall.
Meanwhile, mortgage application activity rose in the week ending Aug. 3, according to the Mortgage Bankers Association. The Refinance Index jumped 9.1%, to 1881.1, while the Purchase Index was up 7.4%, to 447.4. As a percent of total application activity, the refinancing share was 39.9%, up from 39.4% previously. ARM share was also slightly higher at 22.5% versus 22.3%.
FHLMC Reports Second-Quarter Cash-Out Refis
Freddie Mac reported that in the second quarter of this year, 83% of Freddie Mac-owned loans that were refinanced resulted in new mortgages with loan amounts at least 5% higher than the original mortgage loan. This is unchanged from quarter one.
Mortgage rates in the second quarter versus the first quarter were, on average, up only 14 basis points (6.36% in the second quarter versus 6.22% in the first quarter, while the Refinance Index was also little changed at an average of 2050 in the first quarter and 1938 in the second quarter.
"Borrowers who are refinancing were motivated by a desire either to extract equity or to obtain more favorable terms than on their adjustable-rate mortgage, which may be nearing an interest rate adjustment," Freddie Mac Chief Economist Frank Nothaft said.
With mortgage rates moving steadily higher and refinancing activity lower based on the MBA's Refinance Index, cash-out refinance activity is expected to decline in the second half of this year.
Freddie Mac estimates that the refinance share of mortgage originations will decline by as much as 10 percentage points in the second half. In addition, the GSE noted that originations tend to be lower in the second half of the year as a result of seasonal market conditions. Given both, the agency expects the volume of cash-out activity to decline by roughly a third later this year, said Freddie Mac Deputy Chief Economist Amy Crews Cutts.
For the second quarter, Freddie Mac's quarterly survey also stated that the median ratio of new-to-old interest was 1.02. This means that one-half of those borrowers who paid their original mortgage and took out a new one increased their loan rate by 2%. This remained the same as in the first quarter of this year but was down slightly from 1.04 for the fourth quarter of 2006.
The median age of the refinanced loans was 3.5 years, up from 3.3 years in the first quarter. Freddie Mac said this was the oldest median age in nearly seven years!
The median appreciation of the refinanced property was 23%, compared with 25% in quarter one. This is the lowest since the first quarter of 2005, when it was also 23%.
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