Flows were mixed last week as investors returned from their long winter nap. Selling to move down in coupon was noted from hedge funds, insurance companies and servicers. Originators, meanwhile, were average to slightly below average sellers on the week. Over the week ending last Wednesday, spreads were flat to slightly tighter in 30-year FNMA 4.5s through 5.5s, and two to three basis points wider in 6s and 6.5s. The widening in the higher coupons was due, in part, to curve flattening and profit taking. This also impacted higher coupon FNMA rolls. For example, the drop in yield for the 6% coupon was at 5.75% last Thursday from 6.875% earlier in the week. The weakening encouraged hedge funds to switch and begin buying Ginnie Mae and Gold 6s.
The outlook for mortgages in 2005 appears favorable, though performance is not going to be as strong as 2004, report Bear Stearns analysts. In recent comments, analysts said this year's showing depends on several factors, the first being the direction and volatility of interest rates. Bear Stearns notes a steady flattening of the curve with a modest response from the long end make for a good market for MBS. The second is the investment appetite of Asian central banks. Asian buying of MBS picked up last year and is expected to continue due to higher U.S. dollar reserves in China and Japan. The third is the effect of new MBS products that could impact prepayments and fixed rate agency supply. Other factors supportive of MBS, added UBS, include declining volatility as the market backs up; corporate crossover buying; leading UBS to believe net fixed supply will be negative for 2005.
Mortgage applications decline
The Mortgage Bankers Asso-ciation reported that mortgage application activity declined for the week ending Dec. 31. The Purchase Index was down 14% to 417 on a seasonally adjusted basis, while the Refinance Index was 6% lower to 1701. As a percentage of total activity, refinancings rose to 48% versus 46.2% in the previous report; ARM share declined to 32.6% from 33.8%.
Meanwhile, Freddie Mac reported a slight decline in mortgage rates for last week. The 30-year fixed rate mortgage rate came in at 5.77%, down four basis points; the 15-year fixed rate averaged 5.21% versus 5.23% last week and the one-year ARM rate fell nine basis points to 4.10%. Freddie Mac also began reporting the average rate for five-year Treasury-indexed hybrid adjustable-rate mortgages. The inclusion of the 5/1 ARM was prompted by Freddie's annual ARM survey confirming that "the market for hybrid ARM products has grown large enough for us to track the direction this market segment is taking" said Freddie's Deputy Chief Economist Amy Crews Cutts. For the previous week, the average was 5.03%.
Looking ahead to this week's MBA mortgage application survey, JPMorgan Securities expects the Refinance Index to hold around the 1700 area.
Prepayment outlook
The housing agencies release December prepayment reports on the evening of Jan. 6, as this is going to press. Consensus predicts December speeds will increase around 1% to 3% with the increase primarily attributed to a higher day-count of 22 days in December versus 19.5 days in November. Over this period, mortgage rates held steady averaging about 5.72% in October, 5.73% in November, and 5.75% in December. The Refinance Index also held within a narrow range, averaging 2161 in October, 2154 in November, and 1841 in December.
In the months ahead, prepayments are predicted to slow by roughly 5% to 10%. Morgan Stanley adds that with mortgage rates holding steady, most of the slowing will be due to day-count and seasonality. The day-count is 20 in January and 19 in February.
The current general outlook for prepays in 2005 is for faster than expected speeds to continue. This assumes the Federal Reserve stays on its current course of action and that the long end holds relatively stable. The reason, according to Bear Stearns, is the rise in ARM products and IO loans, as well as the development of new loan products stimulating borrower demand. Bear Stearns estimates that the impact of higher ARM products and fast prepayments should cause the fixed rate MBS market to grow only 1% to 2%. Analysts are currently anticipating agency MBS production to fall around 25%, which would put monthly production at $62 billion - the lowest since February 2001. However, with prepayments slowing down, total agency MBS outstanding should see some slight gains.
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