There were modest rebounds early last week after the previous week's flight-to-quality rally on subprime write-down fears. The highlight on the subprime topic through midweek last week was the departure of Citigroup Chairman and CEO Charles Prince and the banks expected write-down of $8 billion to $11 billion or more in subprime related investments in Q4. From the markets close Friday, Nov. 2 through Tuesday, Nov. 6, the 10-year Treasury note lost 17/32, with the yield increasing to 4.3% from 4.2%. The 2s10s curve steepened as well to 68.2 basis points from 65.8 basis points. In mortgages, volume in the first half of the week was about normal in mixed flows. Volume ticked up sharply Monday, and swap spreads moved wider with the Citi news, as well as on rumors about the potential write-downs at other financial institutions. MBS traded poorly as a result, with active selling from servicers, hedge funds and money managers. And weakening in rolls didnt help. The widening brought some buying interest in the overnight market that was met by active selling from the domestic side Tuesday. At noon, with mortgages wider by nine ticks to swaps, heavy buying emerged from a wide range of investors. In general, flows were directed primarily up in coupon, and 15s saw good support.
Originator selling through midweek averaged between $1 billion and $1.5 billion. Supply was concentrated primarily in 6s and to a smaller extent in 5.5s.
Mortgages, along with competing cross sectors, are putting in a poor showing so far in November. According to Lehman Brothers, the MBS Index is down 66 basis points, the ABS Index is lagging by 32 basis points, CMBS is off 62 basis points, and corporates are the worst performing at -69 basis points.
Update on Housing, Subprime and Credit
Citigroup's Chairman and CEO Charles Prince resigned on Sunday, Nov. 4 in the wake of sizeable write-downs related to subprime mortgage holdings. The firm announced it would write down between $8 billion and $11 billion in the fourth quarter, possibly more. In addition, Citigroup announced the creation of a subprime portfolio group to be managed by Richard Stuckey, who was instrumental in unwinding Long-Term Capital Management's bad bets following its collapse in 1998.
Last Tuesday, the U.S. House Financial Services Committee passed H.R. 3915, the Mortgage Reform and Anti-Predatory Lending Act of 2007, by a vote of 45 to 19. The legislation would establish a federal duty of care, prohibit steering and call for licensing and registration of mortgage originators, including brokers and bank loan officers. It would also set a minimum standard for all mortgages, which would require borrowers to have the reasonable ability to repay and attach limited liability to secondary market securitizers that package and sell interests in home mortgage loans outside these standards. Investors in these securities, however, would not be liable. In addition, the legislation would expand and enhance consumer protections for "high-cost" loans under the Home Ownership and Equity Protection Act. The bill now goes before the full House of Representatives. Meanwhile, Senator Christopher Dodd, chairman of the Senate Banking Committee, has said that he is drafting a similar proposal.
Several trade organizations have expressed reservations regarding the proposed legislation. In particular, Mortgage Bankers Association Chairman Kieran Quinn said, "While the committee accommodated a number of concerns we raised with the bill, we regret that the committee did not address a series of other important issues. We cannot support a bill that does not provide broad national uniformity in the fight against predatory lending. We want a clear, national standard for lenders to adhere to and for consumers to hold lenders accountable to.
On Wednesday, Nov. 7, the House Judiciary Committee was meeting to mark up H.R. 3609, the Emergency Home Ownership and Mortgage Equity Protection Act of 2007. The bill would allow bankruptcy judges to modify the mortgage terms for homeowners that become insolvent. The bill had been previously delayed as a result of opposition from Republicans.
Industry groups are also opposed to this bill, arguing that it would increase home ownership costs through higher down payments and interest rates. In addition, the groups say the legislation would decrease liquidity in the secondary markets through increased risk in the secured lending process.
New Yorks Attorney General, Andrew Cuomo, is widening his investigation of the mortgage industry to include Fannie Mae and Freddie Mac. Cuomo indicated there was a significant new development involving the GSEs. Previously, hed filed a lawsuit against an appraisal company, accusing it of inflating home values under pressure from Washington Mutual, although WaMu is not named in the suit. The Office of Federal Housing Enterprise Oversight Director James B. Lockhart responded by saying, "I look forward to hearing from the New York Attorney General's office on the nature of his inquiry and of the requests for assistance from the GSEs that are subject to OFHEO regulation."
This week's shortened trading session includes key inflation data, with PPI and CPI on Wednesday and Thursday, respectively. Other economic releases due are the International Trade and Treasury Statement on Tuesday; Business Inventories and Retail Sales on Wednesday; Empire State Manufacturing and Philly Fed Surveys on Thursday; and Industrial Production/Capacity Utilization, Michigan Sentiment and Treasury International Capital Flows on Friday.
In mortgages, 48-hour notification begins Thursday for Class B (15-year MBS) and Friday for Class C (30-year Ginnies).
The MBS outlook continues to be mostly discouraging. Last week, JPMorgan analysts said they were holding with their negative recommendation on the mortgage/swap basis. They cited sharp spikes in volume over the short term as the ongoing subprime write-down drama continues to unfold. In addition, there is increasing supply in agency MBS. Meanwhile, RBS Greenwich Capital turned to neutral from a modest overweight, as the sector continued to get hit by the subprime turmoil. Heading into year end, balance sheet constraints are also likely to impede liquidity. Other negative factors include the lack of a marginal sponsor and weakening rolls.
On the other hand, UBS moved to a modest overweight from neutral on the mortgage basis because of the recent underperformance of the sector. UBS analysts added that they like the basis in 30-years and really like it in 15-years. Specifically, they said they would be long 15-year FN or Gold 5s versus the Treasury curve. They also mentioned that 15-year MBS look attractive to 30s on an OAS basis. In addition, 15s don't have the supply issues that are affecting the 30-year sector, they said.
October Prepayment Review
Speeds on Fannie and Freddie MBS were generally in line with expectations. Overall, Fannie 4.5s through 6.5s rose 11%, while Freddie's gained 16%. This is versus expectations of a 14% increase. The increase in speeds was primarily related to a higher day count-22 days versus 19 the previous month. Lower mortgages and higher refinancing activity also made a minor contribution to speeds.
In particular, speeds on 2006 vintages (except FN 5s and 7s) increased more than 20% from September, while older vintages rose 10% or less. In comments regarding this, UBS analysts said they "believe that new productions are much more sensitive to rallies than seasoned vintages before significant negative HPA (or HPD, home price depreciation) builds in." They add that due to the lack of burnout and larger loan size, new production should react strongly to incentives.
Also potentially impacting premiums are servicer buyouts, Lehman analysts said. Regarding FN 7s, which were the subject of buyouts in September, speeds held steady with the 2006 vintage in particular continuing to prepay at 28% CPR. Credit Suisse analysts said there is a significant divergence in prepayment rates between high and low FICO borrowers, as the cohort has seasoned. "With seasoning, higher speeds on low FICO borrowers are likely driven by higher delinquencies and resultant agency repurchases." They expect the trend of higher involuntary prepayments on weaker collateral premium coupons will remain an important driver of faster prepayments as they season.
In Ginnies, speeds increased less than 10%, excluding 6% coupons. Sixes were the subject of buyouts from one particular servicer previously, which caused speeds to surge. In October, this sector slowed 18% overall.
Paydowns totaled $33.5 billion, according to Credit Suisse, a 12.5% increase from September. Analysts there estimate fixed-rate issuance at $37.3 billion compared to $48.3 billion previously. The decline is related to an increase in prepayments and a 9% drop in gross issuance, they said.
Looking to the November report, speeds currently are seen slowing between 10% and 15%. Influencing the report is a day count lower by two days, further slowing in seasonals related to the winter, as well as the overall weak housing conditions and tighter lending standards. Specifically regarding FNMA 5% coupons, JPMorgan anticipates speeds will slow to below 5% CPR in December. They point out that seasonal factors are 15% lower, and there are three less collection days in that month. This does not factor in the weak housing market. Analysts suggest the situation could linger until March, when seasonals and day counts start to improve.
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