The mortgage market was a relatively quiet last week as participants were mainly on hold for the Federal Open Market Committee's midafternoon statement last Wednesday. The announcement failed to stimulate much reaction, and so the market's focus turned to Thursday's 10-year auction and trying to figure out when - and if - Asia would ever show up.
Monday and Tuesday saw roll-related trading as pool notification began Tuesday for 30-year conventionals. Focus was on FNMA 6s, which saw its roll strengthen. Also benefiting 6s was anticipation that Asia will focus on that coupon - when these investors return. In early trading on Thursday, spreads were a basis point or more wider as the market set up for the 10-year auction. Buying interest was starting to pick up but heavy dealer inventories and some originator selling weighed down the sector. Buying was up-in-coupon as the curve steepened.
The near-term outlook is generally favorable for mortgages with decent bank demand, overseas potential, and limited supply. In addition, Bear Stearns analysts noted, the GSEs have shown some positive portfolio growth recently and volatility remains low. This should keep spreads in a narrow range but a big factor in better mortgage performance is a pickup in buying from Asia.
Any selling from banks is expected to be limited due to large unrealized losses estimated at $17 billion, according to analysts at JPMorgan Securities. They note that in the 1999 to 2000 period when banks' unrealized losses rivaled current levels, banks did not reduce their holdings.
Outside of this, mortgages have additional supporting factors that include "historically strong seasonal demand patterns for MBS during May and a potentially negative technical environment for vega," Credit Suisse analysts said.
Mortgage applications move lower
After a brief gain in late April, mortgage application activity declined nearly 6% overall for the week ending May 5. The Mortgage Bankers Association reported that the Refinance Index was down nearly 9% to 1427.4 while the Purchase Index fell 4% to 416.5.
Lehman Brothers analysts suggest the sharp drop in refinancings appears to be a delayed response to the overall jump in mortgage rates in the past few weeks, as mortgage rates have held steady in the past week or so.
Fixed mortgage rates dip, ARMs little changed
Last week Freddie Mac reported that mortgage rates held steady in its latest weekly survey. For the week ending May 12, 30- and 15-year fixed mortgage rates slipped one and five basis points, respectively, to 6.58% and 6.17%. On the ARM side, 5/1 hybrids averaged 6.22% compared to 6.21% previously, while one-year ARM rates were unchanged at 5.67%.
Freddie's Chief Economist Frank Nothaft attributed the stability in rates last week to the less-than-expected increase in payrolls. "Less-than-expected job growth in April helped mortgage rates to level off this week," Nothaft said. "Even ARM rates were little affected by the Federal Reserve's increase in the federal funds rate." He warns though that, "next week's release of the April Consumer and Producer Price Indexes may lift mortgage rates higher if the figures show an acceleration in inflation."
Looking ahead to this week's mortgage application report, expectations are for the Refinance Index to trend decrease to 1400, and possibly slightly below in response to higher rates.
FNMA speeds fall more than expected
FNMA speeds in April were slower than consensus estimated. The Street was expecting speeds to dip approximately 8% to 10% primarily as a result of the lower amount of collection days - 19 versus 23 in the previous month. However, CPRs were down around 10% to 13% for 4.5s through 2005 vintage 5.5s; and 15% to 20% for more seasoned 5.5s and higher coupons. "While the Easter holiday and higher rates can explain some of the additional slowdown, we see this as another sign of a cooling housing market," Lehman Brothers analysts said.
Gold speeds recorded larger percentage declines for certain lower coupon vintages compared to FNMAs. Speeds on lower coupons are similar to comparable FNMAs. In general, higher coupons declined similar to slightly less than comparable FNMAs. Still, speeds on Golds are 1 to 2 CPR behind comparable FNMAs for many coupons and vintages.
Meanwhile, GNMA speeds were generally in-line with expectations for 4.5s through moderately seasoned 6s. Older 6s and higher coupons prepaid slightly faster. Speeds remain much faster than conventionals for most coupons and vintages.
In a report released last Tuesday, UBS analysts said that the April prepayment reports offered some interesting tidbits. Although discount agency speeds were in line with their expectations, agency speeds actually slowed slightly more than analysts expected on cusp and premium cohorts, noting that only 7% of the 30-year agency universe is marginally in-the-money at current rate levels.
Analysts explained that their "overprediction" on cusp and premium coupons could be tied to the MBA Refinance Index, which has stayed strong despite rising rates over the past two months. They also suggested two additional explanations why this phenomenon is happening. The first one is that despite higher rates, continued cash-out activity driven by strong home price appreciation has kept refinancings robust. The second factor relates to borrowers refinancing out of hybrids, specifically 3/1 borrowers approaching their reset, helped keep the refinance index at higher-than-expected levels.
Analysts also asked why hasn't the ARM percentage rebounded to reflect borrowers refinancing. They said this is because these borrowers are likely moving into fixed rate securities, possibly into fixed rate IOs. Analysts believe that the second reason is the more likely case, adding that the continued fast hybrid speeds support this theory.
Prepayment outlook
Preliminary expectations suggest speeds in May will jump 10% to15% from April primarily due to an increase in the number of collection days to 22 from 19, and stronger seasonals. While 30-year fixed mortgage rates rose 19 basis points on average in April from March, refinancing activity was down just 4% on average.
In recent comments from Credit Suisse, analysts said they do not expect discount speeds to slow down significantly from current levels - unless rates sell-off sharply - as they expect cash-out activity to remain healthy throughout the remainder of 2006.
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