With refinancings and cash-outs waning, net fixed-rate supply for this year is expected to be the lowest since 2000. The current rate of new home sales suggests 2% annual growth in net fixed issuance, says JPMorgan Securities.
ARMs now already make up half of mortgage applications. Also, almost 60% of purchase applications are for ARMs. These factors will lead to no growth in the fixed-rate market, analysts said. Meanwhile, the record level of new home sales only serves as the breakeven, where net fixed-rate supply stays stable. JPMorgan said that if new home sales slow or if the percentage of ARM applications increases, there could be considerable negative net supply in the fixed-rate sector.
Also, at current rates, there is only roughly 5% CPR of equity take-out. In contrast, in 2003, there was an average of 20% CPR contribution from equity take-out. This means the equity take-out contribution has decreased significantly by 75%, said analysts.
Meanwhile, Lehman Brothers expects the hybrid share of origination to hold at or above 45% for the remainder of this year, and stay above 30% in 2005. As a result, the size of the hybrid ARM market is predicted to increase from $1.2 trillion (as of December 2003), steadily rising to $2.1 trillion by the end of 2005. Lehman predicts the outstanding hybrid market share will rise from 20% to 29% by December 2005.
In general, hybrids have a shorter duration than 30-year fixed rates, says Lehman. This, in turn, means that hybrids have greater exposure to the shorter end of the yield curve. Lehman also notes that the convexity of a hybrid pool is around 30% to 40% lower than of a fixed-rate pool. Lastly, the implied volatility exposure of a hybrid is about half that of a fixed-rate mortgage.
First, due to the nature of hybrids, Lehman believes that duration extension in the mortgage market resulting from new supply will be in the front to intermediate part of the curve. Also, the convexity exposure of the mortgage market should increase at a slower pace than the growth in the size of the market. Lastly, the vega or implied volatility of new additions will be much lower, so the vol exposure of the mortgage universe should grow at around half the pace of its size, says Lehman. In addition, Lehman notes that most of the exposure will be in the shorter part of volatility surface.
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