Mortgages performed well last week as the previous week's sell-off moved the market to a higher yield range. The 10-year yield moved above 4.70% following the strong revisions made to the employment report after falling to 4.57% on Nov 1. While the market experienced a moderate rally last week, the 10-year remained above 4.60% resistance and mostly held to the middle to upper end of the 4.60% to 4.70% range. Month- to-date, Lehman Brother's MBS Index is up 14 basis points with year- to- date at 101 basis points in excess return.
Flows over the week were mostly supportive with wide ranging interest from domestic real and fast money, overseas, and servicers, and directed mostly down in coupon. Tuesday was helped by nearly $38 billion that became available through paydowns. From Friday's (Nov. 3) close through Wednesday's close, FNMA 5s and 5.5s were up 17/32nds and 13/32nds, respectively, while 6s and 6.5s rose just 8+/32nds and 4/32nds. Dwarfs saw increases ranging from up 12/32s in 4.5s to up 5+/32s in 6s. The 10-year Treasury, meanwhile, was up 20 ticks over the period.
Originator selling picked up and averaged closer to $2 billion per day versus its normal $1 billion. There were also a number of seasoned and structured bid lists making the rounds in both the 30- and 15-year sectors. The week also included roll related activity associated with Class A (30- and 20-year conventionals) settlement. Rolls were uneventful except for Gold 5.5s and 6s.
Street analysts are mostly constructive on the sector. The recent sell-off provides a more attractive environment for overseas support. Bear Stearns analysts expect further tightening in spreads as conditions such as low volatility, range bound swap spreads, and good demand - particularly overseas - remain favorable. The sector is also seen as more attractive versus alternative sectors. In addition, it reduces the risk of bank selling.
It also appears that if the market does rally moderately, bank selling looks to be limited. Deutsche Bank analysts noted that in the recent rally there was a lack of commercial bank selling of discounts, helping mortgages perform well through the rally. Analysts said it appears that in late September, banks were able to sell positions acquired in late 2005 and early 2006 to reduce their unrealized losses. They focused on these positions because rates at the end of September were similar to earlier this year. Deutsche analysts said it appears the next opportunity for banks to sell a substantial amount of discount paper is 40 to 50 basis points away. This would put the large positions of 30-year 5s that large banks bought in the spring of 2005 at the money.
The week of Nov. 13 promises a heavy economic calendar that includes the inflation reports, retail sales, the Philly Fed Survey, National Association of Home Builders Housing Index for November, and Housing Starts. Minutes from the last Federal Open Market Committee meeting are also released on Tuesday. Within the mortgage sector, Tuesday begins 48-hour day for Class B Securities (15-year MBS), Class C (30-year GNMAs) on Thursday, and Class D (balloons, ARMs, etc.) on Friday.
While there is an overall supportive tone for mortgages, a move through 4.60% on the 10-year is expected to encourage better selling with Asian buying moving towards the sidelines.
Refinance Index jumps 11%
Mortgage application activity moved higher last week in response to the decline in mortgage rates. According to the Mortgage Bankers Association, the Refinance Index surged 11% to 1897.9, while the Purchase Index was up 7% to 402.2. One year ago both indices stood at 1799 and 466, respectively.
Based on number of loans,
refinancings were up higher to 46.3% versus 45% previously. ARM share was also up slightly to 26.4% from 25.9%.
Slight increases
in mortgage rates
Mortgage rates moved up just slightly across the board last week, according to Freddie Mac's weekly mortgage rate survey. Up just two basis points were 30-year fixed mortgage rates, 15-year fixed rates, and one-year ARMs, which averaged 6.33%, 6.04%, and 5.55%, respectively. Meanwhile, 5/1 Hybrid ARMs rose to 6.08% from 6.05%.
"Mortgage rates rose earlier in the week on news of large upward revisions over the past three months in employment figures, but began to drift lower as the market looked more deeply into the numbers," said Freddie Mac's Chief Economist Frank Nothaft. "For instance, in October the construction industry lost jobs, primarily due to the slowing housing market."
Nothaft added that the slowing housing market has removed just a little more than one percentage point from the third quarter GDP growth rate. But, he said, that they expect GDP growth rate will rise in the final quarter of 2006, although the increase is expected to come from areas outside of housing.
The modest increase should keep mortgage application range bound. Over the past five weeks, the Refinance Index has ranged between 1700 and 1900.
October prepays
Overall, prepayments on 30-year FNMAs were in line with expectations for discounts through 2003 par coupons. However, speeds on seasoned 6s and 6.5s came in substantially below estimates. Speeds on the higher coupons were projected to increase close to 12%; however, they came in about half as much on average. In particular, seasoned 6.5s experienced a very muted response to the attractive rate levels available in September. Lehman Brothers analysts said it is puzzling considering that the sell-off in early October should have increased the pull-through rate. They said that these borrowers, many of which have high SATO (Spread at Origination), have an unusually long delayed response to rate incentives. Analysts noticed that this was also the case as well during the rallies of late 2004 and mid-2005. (SATO is the difference between the borrower's loan rate versus current market rates. High SATO pools generally prepay more slowly compared to low SATO pools).
JPMorgan Securities analysts said the mortgage market should view the report favorably as discount speeds did not disappoint on the downside, while premium speeds - particularly 6.5s - remained tame.
FHLMC Gold speed increases were more than FNMAs and were more in line with expectations of over10% to 12%, including the 6.5s. Speeds on GNMAs increased less than expected at around 4% on aggregate versus projections of 9%. While 6.5s were in-line with estimates, lower coupons were generally slower.
Credit Suisse analysts projected paydowns at $37.6 billion, increasing 12% from September. Estimated fixed rate net issuance declined $3.1 billion to $22.3 billion, analysts said. This consists of 30-year FN/FHLMC net issuance of $27.5 billion, 30-year GNMAs at $0.4 billion, and 15-year MBS at less than $5.7 billion.
Prepayment outlook
Speeds in November are expected to slow 3% to 4% on average with discounts showing larger percentage declines versus premiums. JPMorgan anticipates paydowns to hold steady at around $38 billion.
Factors influencing the report include slowing seasonals and one less collection day. On average, the Refinance Index was up less than two percent in October compared to September; 30-year mortgage rates averaged just four basis points lower. Prepayment speeds are expected to decline through February.
"With 90% of the mortgage universe outside of the fixed rate refinancing window and the fixed-to-ARM incentive at near record lows, the theme through the end of the year and the start of 2007 will be continued steady slowing of MBS prepayment cash flows," said Dale Westhoff, senior managing director at Bear Stearns. Seasonal factors and further moderation in housing turnover will be the primary drivers of prepayments going forward, Westhoff added.
Specifically, Bear Stearns projects speeds on 2003 FNMA 5s to decline to 7 CPR by February and 2003 5.5s to be at 9.6 CPR.
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