With rates continuing to drop, investors are moving down in coupon. In particular, 6s finally got hit with selling as the roll weakened on prospects of substantial increases in prepayments in the coming months. Investors have begun moving into the new par coupons - 30-year 5s and 15-year 4.5s.
Researchers at UBS Warburg recommend portfolio managers buy these coupons, maintaining that if the market stays at current levels, these coupons will make up a significant portion of outstandings. In addition, if the market holds or rallies, the securities will outperform.
UBS Warburg projects 30-year 5% coupons will represent 22% to 25% of total production in March; 27% to 30% in April; and 39% to 42% in May. For 15-year 4.5% coupons, UBS Warburg estimates a range of 33% to 36% of total production in March; 39% to 42% in April; and 49% to 53% in May. Related to this, of course, is increased representation in the MBS Indexes.
The analysts expect the coupons will outperform if rates rally due to following three factors: a solid CMO bid; little duration even in the 30-year 5.5s; and the reluctance of investors to pay large premiums. Finally, the firm notes that if the market sells off, these securities would sell no worse (on a duration-weighted basis) than 30-year 5.5s and 15-year 5s.
Originator selling started the week off strong with $3 billion last Monday. It trickled down to more normal levels of $1 billion to $2 billion per day as the week progressed.
Over the Wednesday-to-Wednesday period, spreads widened six basis points in 30-year currents and two to three basis points in 15-year currents.
Refi Index jumps as rates set new record lows
As expected, borrowers responded to the new record low levels in mortgage rates. For the week ending Feb. 28, the Mortgage Bankers Association (MBA) reported that the Purchase Index jumped 12% to 346 and the Refi Index surged 10% to 6614 on a seasonally adjusted basis. The record high on the Refi Index is 6926, which was set last October. In recent comments, Bear Stearns analysts suggested that mortgage rates would have to fall to around 5.60%, which would expose some of the 5.5% universe, in order for the Refi Index to set a new record high.
As a percentage of total applications, refinancings were 74.7%, down from 75.3% in the previous report. At the same time, ARM share increased to 13.8% from 13.2%. Lehman Brothers researchers expect the Refi Index to hold around the 6600 level if mortgage rates hold near current levels; however, a further rally in rates should see the index moving above 7000, which would be a new record high.
This rate level is looking more and more likely given the continuing disappointing economic data and the potential war with Iraq. In fact, Freddie Mac reported a larger than expected decline in fixed mortgage rates for the week ending March 7. A shocker is the 12 basis point drop in 30-year fixed rate mortgage rates to 5.67%. The 15-year fixed rate mortgage rate was also down lower than expected to 5.14% from 5.21%. Lastly, the one-year ARM rate increased a slight two basis points to 3.83%. With rates at these levels, it is becoming increasingly likely that the MBA Refi Index will surge above 7000 and set a new record high.
With rates continuing to move lower, record or near record highs in speeds are expected to continue throughout the spring and early summer. At this time, Bear Stearns predicts peak speeds of 37% CPR on 2002 6s; 51% on 2001 6s; 66% on 2002 6.5s; 68% on 2001 6.5s; 65% on 2002 7s; 67% on 2001 7s; and 63% CPR on 1998 7s. Peaks on seasoned paper are predicted to hit around May and in July for unseasoned paper.
Last Friday, the February prepayment report was released and speeds were expected to hold firm from January's levels.
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