Mortgages continued their tightening trend on Monday for the fifth straight session, but gave it up on Tuesday and Wednesday.

Flows on Monday were supportive with better buying from foreign and domestic banks and money managers adding outright in the lower half of the coupon stack. Hedge funds and servicers were quiet, but became better sellers beginning on Tuesday, while profit taking picked up from real money.

The better selling that began to emerge into midweek was not altogether unexpected, as mortgages have done very well on the calmer tone that has characterized the markets since the Federal Reserve's program initiatives. Mortgages, in fact, were acting a bit more normal with investors taking advantage of weakness and selling on strength. However, overall MBS volume remained below normal running at just 60% of the 30-day average in the first two-days of trading. In fact, volume has been below normal since mid-March.

In other mortgage activity, dollar rolls strengthened into the Class A net out and 48-hour pool allocations, 15s mostly lagged 30s, while GNMA/FNMA swaps were mixed. Originator selling was very light, averaging just $1.5 billion per day with supply focused in 5s and 5.5s. However, originator selling of specified pools was stronger due to the approaching pool allocations.

Month to date through April 8, Lehman Brothers MBS Index outperformed Treasurys by 52 basis points. In competing sectors, ABS was up 30 basis points, while CMBS and U.S. credit surged 100 basis points and 120 basis points, respectively.

Mortgage Outlook

In Street research last week, analysts acknowledged the better tone in the markets as a result of all the Fed actions and Congressional activity focused on helping the housing market.

Specifically, Lehman analysts said they still don't recommend an overweight at the moment because of the heavy supply situation and uncertain demand sources. In the current environment, they prefer up-in-coupon, particularly in FN 7s and 6.5s. Analysts also recommended an overweight to hybrids over fixed-rate mortgages.

JPMorgan Securities recommended staying close to home on the mortgage/swap basis, despite the historically wide spreads. It also warned about the projected heavy supply, and that there is still some deleveraging from REITs and hedge funds that will continue. Its preference was also for up-in-coupon, to buy 15-years due to better convexity and wide OAS and ROE versus 30-years, and certain alternative mortgage related sectors.

UBS analysts remained neutral on the mortgage basis. Analysts noted that, as a result of the recent tightening in mortgages, the no-point 30-year rate is now below 6%. They cautioned that refinance activity could pick-up dramatically if rates decline another 20 to 30 basis points.

Application Activity Increases

As expected, mortgage application activity increased in the week ending March 4. According to the Mortgage Bankers Association, the Refinance Index rose 3.4% to 2724.7, while the Purchase Index increased 8.1% to 384.7. Contributing to the gains was a jump in Federal Housing Authority lending. The MBA noted that its Government Index was up nearly 13%, while its Conventional Index increased less than 4%.

As a percent of total applications, refinancings slipped to 52.2% from 53.4%. ARM share was higher at 6.5% compared to 5.4% previously.

Mortgage rates held steady during the week with the 30-year fixed contract rate three basis points higher to 5.78%. One-year ARM rates increased 6 basis points to 7.06%.

Prepayment Outlook

Prepayment speeds on FNMAs are currently projected to be up slightly overall in April, primarily due to increases in the 5% coupon. Higher coupons, in aggregate, appear to be flat to lower in early predictions. In general, a two-day higher day count looks to be mostly offset by higher mortgage rates and lower refinancing activity.

For example, the 30-year fixed mortgage rate averaged 5.97% in March versus 5.92% in February, while the MBA's Refinance Index averaged 13% lower from the previous month at 2919. Speeds in the upcoming reporting months are expected to pick up - albeit very modestly - with the help of seasonals.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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