Mortgages turned in a fairly active week with participation from a wide range of investors - overseas, money managers, indexers, CMO desks, servicers and other fast money. A combination of further curve flattening, heavy supply in 5.5s, along with the market holding within its range, resulted in active down-in-coupon flows. Originator selling picked up last week and averaged over $1.5 billion per day with around 70% in 5.5s and the remainder in 5s.
Servicers were particularly active last week. In its mid-week commentary, JPMorgan Securities noted that the servicing community appears to have significantly increased its MBS exposure, attributing the rise in an attempt to hold earnings stable as origination volume slows. If so, this is a potential risk to mortgages causing JPMorgan to be near-term negative on the sector. Other reasons include marginal carry and limited spread tightening potential. Most other analysts, though, are neutral to slightly positive on the sector.
The supportive tone in mortgages is anticipated to hold as long as yields stay near current levels. Risks to mortgages are seen if the 10-year Treasury sells off sharply towards the 4.5% area, or rallies back towards 4%.
There were also the previous week's news regarding the Chinese RMB revaluation and Senator Richard Shelby's (R., Ala.) proposed GSE bill. Regarding the yuan revaluation, consensus among most MBS analysts is that any impact to the MBS sector is not in the foreseeable future. For example, Credit Suisse First Boston noted that any decline in MBS demand from China should appear as a decline in the US trade deficit. Deutsche Bank Securities analysts also do not believe mortgages will be the first sector where China cuts back. They expect overseas investors to start branching out into other MBS sectors such as in structured and credit products. Still, there is the potential for increased interest rate volatility that could affect mortgages.
As expected, Senator Shelby's bill, The Federal Housing Enterprise Regulatory Reform Act of 2005, cleared the Senate Banking Committee last Thursday by a vote of 11 to nine. In comments following the passage, Senator Shelby acknowledged that concessions on affordable housing would probably have to be included in order to get Democratic support in the Senate.
UBS also adds there is little middle ground between this bill and the recently passed House Financial Services bill, "making it unlikely that there will be a GSE Reform Bill this year."
Application activity declines
in latest survey
As expected, refinancing activity declined in response to higher mortgage rates. The Mortgage Bankers Association reported that the Refinance Index fell 11% to 2320 for the week ending July 22. Purchase activity, however, held steady at 485 versus 489 previously. As a percentage of total application activity, refinancings were 42.9%, down from 45.7% in the previous week. ARM share, meanwhile, increased for the third straight week to 29.4% from 28.5% by loan number. The high is 36.6% for the week ending March 25.
Mortgage rates rose for the fourth straight week and are at the highest levels since mid-May. Freddie Mac reported that the 30-year fixed rate mortgage rate averaged 5.77% for the week ending July 29, up four basis points from last week. The 15-year fixed mortgage rate rose to 5.34% from 5.32%; the 5/1 hybrid ARM rate gained one basis point to 5.27%; and the one-year ARM rate reported in at 4.46% versus 4.42% previously.
Refinancing activity is expected to have slipped lower last week with the continued move higher in mortgage rates. JPMorgan expects the Refinance Index to decline roughly 10% in this week's release to the 2000 area. UBS also is expecting the Refinance Index to fall below 2000 in the next week or so.
Prepayment outlook
Prepayments over the next few months are strongly influenced by day count. July has 20 business days; 22 in June; August, 23 days; and September, 21 days. July speeds are projected to increase about 5% overall as the lower day count partially offsets stronger refinancing activity as a result of favorable rates in late June and early July which had the 30-year mortgage rate down to its lowest level in over a year.
For the September prepayment forecasts, there have been some modest downward revisions of around 1% to 2% CPR, affecting primarily premiums given the upward movement in interest rates. Meanwhile, UBS analysts anticipate turnover speeds to remain robust in coming months driven primarily by cash-out activity and strong home price appreciation.
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