Mortgage flows were generally light as the market waited for late week data, particularly Friday's CPI report. Starting midweek, servicers and fast money were moving down in coupon as the market strengthened. There were pockets of buying from real money - mostly in higher coupons, while Asia remained mostly absent. In addition, there was also better buying in 15s versus 30s. Overall, however, the week saw continued better selling. Originator selling, meanwhile, held to around its $1 billion per day average.
The highlight of the week was actually related to Class A settlement. The market was jolted as those taking delivery received FNMA 5 mega pool 745275. This was the largest of the three super megas from the January/February period, noted JPMorgan Securities strategic principal trader David Montano. He added that this wasn't the only recent mega that has reappeared. In fact, several billion in megas off FNMA 5s created this summer have also reappeared and has caused the float in FNMA 5s to rise substantially. This could increase further if the market continues to rally, Montano said. In addition, he noted that the Street is heavily long seasoned FNMA 5s from money manager bid lists. As a result, Montano believes that pay-ups will flounder in the next few months as prepayments converge on TBAs and the 2003 vintage.
Mortgages lost a good portion of their September gains last week in part as the market strengthened Tuesday and Wednesday. Month-to-date through Sept. 13, Lehman Brothers MBS Index is up six basis points versus Treasurys compared to15 basis points over through Sept. 8.
Mortgages are seen as very directional currently, which means that the sector has been lagging in rallies and outperforming in sell-offs. Furthermore, mortgages are expected to lag significantly if the 10-year yield breaks through 4.75% as this could lead to real coupon compression as the longer duration paper outperforms in a rally. Additionally, this will also raise prepayment concerns regarding 6% coupons and is also likely to lead to increased volatility.
Analyst sentiment remained neutral to positive on the sector last week given the "directionality" of the sector and attractive fundamentals. Other favorable factors discussed by analysts included a stable Fed outlook, tightening in swap spreads and lower volatility. Preference remains up in coupon.
Despite the favorable outlook, analysts note that this rosy scenario could turn on a dime, especially if the Federal Open Market Committee resumes its tightening. For example, Barclays Capital analysts last week moved to neutral from overweight on concerns of changing investor expectations regarding the FOMC heading into October. Analysts noted the performance gains in mortgages in the past two months have been driven by active buying, particularly from real money, on belief that the FOMC was done tightening. Barclays researchers believe that this is going to be tested in October with strong economic growth as well as higher core inflation requiring the FOMC to increase rates at the October meeting. Analysts are also concerned about the slowing housing market and the impact on speeds and to valuations.
Purchase activity increases again
Mortgage application activity rose 3.2% for the week ending Sept. 8, according to the Mortgage Bankers Association. Like the previous week, the increase was due to higher purchase activity. On a seasonally adjusted basis, the Purchase Index rose 5.3% to 410. This is the first time since the beginning of July that the Index has been above 400.
Meanwhile, after slipping 1% in the previous report, the Refinance Index held steady at 1597 versus 1595 after adjustment for the holiday.
Of particular interest lately in the MBA's report is the widening gap between the "average refinancing loan size" and the "average purchase loan size". JPMorgan's Montano reported recently that over the last month, the average refinancing loan rose to an all time high of $262,000 from $256,000, while the average purchase loan declined to $216,000 from $223,000. He said the current difference between the two ($46,000) is the largest on record and he believes this anomaly is not going to go away. Montano said the "normal" course is for purchase loans to be larger than refinance loans. He attributes the persistent deviation from the norm to heavy ARM-to-fixed refinancing activity. The decline in the average purchase size also indicates potential for home price depreciation, he notes, for at least a quarter or two.
Mortgage rates decline in latest FHLMC survey
Mortgage rates resumed their downward trend last week after an upward blip the previous week following six straight weeks of declines. The decline of mortgage rates was anywhere from three to five basis points according to Freddie Mac's survey. The 30-year fixed mortgage rate averaged 6.43% compared to 6.47% previously. This is the lowest mortgage rates have been since April 7 when it also averaged 6.43%. In 15-years, mortgage rates fell five basis points to 6.11%. This is also the lowest level 15-year rates have been since April 7 when it averaged 6.10%. On the adjustable side, 5/1 hybrid rates were four basis points lower to 6.10% and one-year ARM rates reported in at 5.60% versus 5.63% previously.
"Although 30-year mortgage rates are about three-fourths of a percentage point higher than they were last year, it's good to keep in mind that rates have dropped from the high of 6.80% reached just eight weeks ago," said Frank Nothaft, Freddie Mac vice president and chief economist. "And with short-term interest rate increases seemingly on hold, for a while at least, interest rates over all should not experience any big shifts in either direction."
Prepayment outlook
Speeds are expected to decline in September by around 10% to 15% in large part due to a lower day count - 20 days versus 23 days in August - and slowing seasonals. Discounts are particularly likely to feel some impact as well from the slowing in the housing market, while slowing in higher coupons will be partially offset by the improvement in mortgage rates in August and the pick up in refinancing activity. For August, 30-year fixed mortgage rates averaged 6.52% compared to 6.76% in July, while the average of 1584 on the MBA's Refinance Index was up nearly 14% over July. In general, 6% coupons and higher will feel the influence of the better refinancing environment in August.
Looking into October and November, speeds are expected to record moderate gains of around 5%, largely as a result of an increase in the number of collection days to 21, but also from the pick up in refinancings in August. Speeds in November are seen slowing about 8% to10%.
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