Volatility increased as the market sold off ahead of late week's data that included PPI and CPI. This triggered better selling in mortgages, particularly in Fannie Mae 5s, where traders reported the sale of a very large position by a bank portfolio. This led to additional selling and when all was said and done, between $6 billion and $9 billion in FNMA 5s hit the Street between Tuesday and Wednesday, JPMorgan Securities confirmed.
The selloff also brought backup in coupon trading and preference for 15s versus 30s. Servicers were reported to be strong sellers as well. Originator selling was limited and held to around $1 billion per day on average, mostly in 5.5s. Lehman Brothers noted that originators are short duration currently and have been holding onto new production - hence, the lack of supply in recent weeks.
Over the week, spreads on 30-year Fannie Mae 4.5s, 5s and 6.5s moved out two basis points; 5.5s were one basis point wider; and 6s were unchanged. In addition to up- in-coupon, 6s benefited from roll-related trading. Meanwhile, in 15s, spreads were two and one basis points weaker, respectively, for 4s and 4.5s; and unchanged for 5s and 5.5s.
Street analysts remain neutral to positive on the mortgage sector. JPMorgan said late last week that it is holding neutral in anticipation of additional widening, but analysts acknowledge the basis has become more attractive. UBS, on the other hand, upgraded its position to modest overweight from neutral. Researchers offered two reasons for the upgrade. For one, the recent underperformance is due primarily to an increase in volatility. Also, they have not seen bank selling at these rate levels. If banks were going to sell, UBS says, it would seem that current levels would provide an attractive exit point.
Regarding volatility, Bear Stearns believes the changing structure of the volatility markets give vol room to move lower - a benefit for mortgage investors. MBS continues to be one of the better places to generate income and, despite the recent increase in prices, an above-index weighting in MBS makes sense, said analysts.
Mortgage application activity declines 6%
Mortgage application activity slowed modestly for the week ending July 9, said the Mortgage Bankers Association (MBA). Analysts had been expecting activity to increase slightly despite the holiday-shortened week due to the sharp drop in mortgage rates last week. In particular, the Refinancing Index was expected to increase to the 2000 area from 1770, but instead fell to 1662. The week included the Fourth of July holiday, which can skew results. Lehman noted that the MBA used a one-day seasonal adjustment. If it had used a 1.5-day adjustment, the Refi Index would have increased to 1900.
The MBA also reported a 6% decline in the Purchase Index to 469 last week. As a percentage of total application activity, refinancings held unchanged, at 35.8%. Meanwhile, ARM share fell to 31.5% from 34.1%.
Mortgage rates were little changed, as expected, according to Freddie Mac's latest survey. For the week ending July 16, the 30-year fixed-rate mortgage rate was 6.00% versus 6.01% in the previous week. This was the fifth straight week of declines and brings rates to their lowest level since late April. The 15-year fixed-rate mortgage rate was 5.40%, down two basis points, while the one-year ARM rate slipped three basis points to 4.02%.
Looking ahead to this week's mortgage application activity survey, Lehman expects the Refinancing Index to hold below 2000 in the near term. However, in comments prior to the MBA's release, Countrywide Securities noted that while their overall activity was lower for the week due to the holiday, on a daily basis, activity levels actually rose.
Impact of lower rates to affect September prepays
The recent strength in mortgage application activity is expected to show up beginning in August and more fully in the September prepayment reports. Current consensus expectations predict a decline of around 20% for Fannie Mae July speeds, little change in August, and then a 15% increase in September. For example, 2003 Fannie Mae 5s are predicted to prepay at 9% CPR in July, and 10% CPR in August and September. The vintage prepaid at 12% CPR in June. The 2003 5.5s are anticipated to prepay at 14%, 15% and 17% CPR for the next three months versus 19% CPR last month.
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