Mortgages experienced overall better buying in normal-to-above-normal volume in the first half of last week. Contributing to this on Monday and Tuesday was a lack of data and big headline news that led to intraday backups in yields and some easing in volatility.
Wednesday, however, saw a return of the flight to quality bid following a weaker-than-expected existing home sales report, along with other negative news related to housing, subprime and credit woes. Still, mortgages were holding their ground, even as fast money selling began to pick up around midday.
On midday Wednesday, Oct. 24, the 10-year Treasury was up 22/32nds to 103-13 with the yield at 4.318%. Prices reached their low for the month on Oct. 12 when previously released data had significantly reduced the odds of a 25-basis-point cut by the Fed at the end of the month. At that Friday's close, the 10-year Treasury price was at 100-16 with the yield at 4.685%. The yield has since fallen nearly 37 basis points. In addition, 2s10s spread is at 61.1 basis points, compared with 46 basis points as of the close of Oct. 12.
Interest was focused primarily in the belly of the MBS stack with participation from servicers, real money, money managers and hedge funds. Asia remained a limited participant. The sharp rally on Wednesday was contributing to active convexity buying down in coupon from 6.5s through 5.5s into 5s. Originator selling was averaging about $1.5 billion per day in the first three trading days last week. Supply was essentially split between 5.5% and 6% coupons. Last week also saw some large specified bid lists. There reportedly was a list of more than $3 billion Gold MBS, which contributed to weakness in the FG/FN swap.
MBS returns remain off their highs of earlier this month, but they are in positive territory. According to Lehman, the MBS index had excess returns in the first 23 days of October of 34 basis points. It is now leading ABS (which had +15 basis points), CMBS (-32 basis points) and corporates (+30 basis points).
Another Round of Housing/ Subprime/Credit Worries
On Wednesday, several reports came out regarding the housing and mortgage market struggles.
* Existing home sales dropped 8% to 5.04 million units compared with expectations of a decline to 5.2 million. In addition, inventory increased to a 10.5-month supply, which is an eight-year high. The data was influenced by the financing crisis that reared up in August and extended into September, which suggests potential further weakness in the October report.
* Merrill Lynch reported a $7.9 billion write-down on subprime mortgages. This was larger than expected and the stock market reacted negatively with the Dow down over 150 points at midday on Wednesday, Oct. 24. In addition, all three of the ratings agencies cut their ratings on the investment bank and also retained a negative outlook on the firm.
* Axon Financial SIVs were forced into an irreversible enforcement event, which means that assets will likely have to be sold in order to repay debt.
* Countrywide Financial said that it might change the terms on $16 billion in adjustable-rate mortgages before the end of 2008 in order to help prevent borrowers from defaulting on their loans. Recently, Countrywide reported it would take a pretax restructuring charge of as much as $150 million and potentially cut 12,000 jobs.
This week brings month end and some key economic reports, including the first readings on Q3 growth and October employment. In addition, beginning on Tuesday, the FOMC will meet for two days with a statement issued on Wednesday at 2:15 p.m. Following the existing home sales report last Wednesday, the odds for a 25-basis-point cut in the fed funds rate had risen to nearly 100% on Oct. 31.
As far as the economic calendar goes, it starts Tuesday with consumer confidence, followed on Wednesday by the ADP employment report, Q3 employment cost index, the advanced Q3 reading on GDP, Chicago PMI and construction spending. Thursday's reports include initial claims, personal income and outlays, ISM index, and pending home sales. Finally, on Friday, there is the employment report along with factory orders.
There are near-term traditionally supportive events looming for the MBS sector. This week it's the month's end and the employment report-which tends to benefit mortgages on the drop in volatility following the news. Looming next week is reinvestment of paydowns (Wednesday, Nov. 7) and 48-hour notification on Class A (Thursday, November 8). Rolls have improved recently as LIBOR has moved lower. Other potential positives for mortgages include another fed funds rate cut, and possibly new ones looming, as well as the steepening in the curve. At the same time, supply continues to grow and a marginal investor remains absent. In August, Freddie Mac's and Fannie Mae's net issuance totaled over $47 billion, and in September, Freddie reported net issuance at nearly $39 billion. In addition, housing, subprime and credit issues remain a burden on the sector.
In research last week, analysts had neutral-to-negative outlooks on the sector. For example, JPMorgan Securities said it was holding with its underweight recommendation on the mortgage/swap basis because of continued issues of supply, weaker HPA, uncertain sponsorship, unwinds of SIVs, and unimpressive OAS levels. Regarding sponsorship, a trading source noted that overseas, GSEs and real money seem pretty full currently, suggesting limited demand from these sources. Another source noted, too, that banks were generally sidelined and that previously when FN 5.5s reached 99-00, significant bank selling followed. As of midday Wednesday, Oct. 24, FN 5.5s were bid at 99-05+.
Refinancing Activity Picks Up
The Mortgage Bankers Association reported a slight increase in overall mortgage application activity on a mixed report. For the week ending October 19, its Refi index rose 4% to 2059.3, while the purchase index slid 3.1% to 415.9.
Contributing to the increase in refinancing activity was the improvement in mortgage rates related to the sharp flight to quality rally amid the increasing housing, subprime and credit risks to the economy. From Friday Oct. 12 through Friday Oct. 19, the 10-year Treasury yield rallied 28 basis points to 4.401%. The MBA reported in its weekly survey that the average contract interest rate for 30-year fixed-rate mortgages declined to 6.21% from 6.40%.
With the improvement in mortgage rates, further gains are anticipated in the Refi index in the MBA's next report. Currently, Lehman Brothers analysts predict that the Refi index will increase to the 2100-2150 area. As a percent of total applications, refinancing share rose to 47% from 45.3%. ARM share was also higher at 14.2% from 13.5% in the previous week.
After declining in September, speeds are anticipated to recover to some extent in October as day count increases from 19 to 22 days. In addition, the period has covered a more favorable mortgage rate environment which has stimulated refinancing activity to some extent. Speeds are predicted to increase about 15% overall in October. Looking further out to November, speeds are projected to decline 12%-13% overall as a result of a lower day count (20 days) and declining seasonals. Further declines of 6%-7% are anticipated for December at this time.
Regarding Ginnie 6%s, speeds are seen slowing substantially in October following large increases in speeds in September. Last month, for instance, 2006 vintage increased 73% and 2005 was 76% faster than August. The increase is believed to be from servicer buyouts. In recent research from Merrill Lynch, analysts found that, in fact, prepayments on GN 6s from most servicers declined, while Wells Fargo jumped to 25.4% CPR from 7.9% CPR in August.
Freddie's Retained Portfolio Plummets 31% in September
Freddie reported a 31.2% plunge in its retained portfolio for September after recording a 19.3% gain in August. This brings the annualized growth rate to 1.7% from 6% previously. The ending balance of the portfolio declined $19.1 billion to $713.2 billion. Under OHFEO's revised limit of $735 billion unpaid principal balance, Freddie has room to add $22 billion.
Freddie Mac said in its monthly volume summary that the increase in retained portfolio sales, in part, reflects activities to maintain a regulatory capital surplus over the 30% mandatory target capital surplus.
The drop was primarily due to sales of Freddie PCs and structured securities amounting to $18.6 billion. Non-Freddie Non-Agency MBS holdings also were lower by $3.1 billion. Meanwhile, Non-Freddie Agency MBS holdings and mortgage loans rose $2.7 billion overall.
Issuance and net issuance of PCs and structured securities also surged in September. Issuance totaled $54.3 billion, up from the $35 billion to $42 billion range that it had run at from January through August. Net issuance jumped to $38.9 billion from the $16 billion to $21 billion monthly amounts in the previous eight months. September's growth rate was nearly 29% compared with 12.4% in August. Year to date, growth is running at 16.9%.
FHLMC also reported net retained commitments totaling $11.5 billion in September compared to $20.4 billion in the previous month. Ninety-day-plus delinquencies for all loans increased 2 basis points to 46 basis points in August. This consisted of a 2 bp increase in non-credit enhanced mortgages and a 4 basis point gain in credit enhanced loans. Finally, the duration gap remains unchanged at zero months.
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