Mortgage activity was quiet in the holiday-shortened trading week. Unlike the previous session when convexity-related trading dominated, last week carry and low volume took precedence. This led to more up-in-coupon trading. Also contributing to the move higher in coupon was the better performance in discount coupons on the recent strong rally.

Over the past week, spreads were 11 basis points tighter in 30-year Fannie Mae 4.5s; five basis points better in 5s and 5.5s; and four basis points firmer in 6s. In 15s, spreads moved in four basis points for 4s and two basis points for 4.5s. Higher coupons were flat to slightly wider.

Mortgages outperform in June

The MBS Index put in its strongest performance since September 1999, according to Lehman Brothers. In the month of June, the MBS Index recorded 56 basis points in excess return versus Treasurys. This compares with 20 basis points of excess return for the Aggregate; 12 basis points of excess return for Agencies; zero basis points for investment-grade corporates; and 13 and 14 basis points of negative return, respectively, for ABS and CMBS. Year to date, the MBS Index is the second-best performing sector, with 36 basis points in excess return. The ABS sector is the top-performing one, with 53 basis points in excess return.

Mortgage application activity jumps

The Mortgage Bankers Association (MBA) reported strong gains in application activity for the week ending July 2. The Refinancing Index jumped nearly 28% to 1770, while the Purchase Index surged 15% to 501. The Purchase Index is just shy of its record high of 502, hit on Jan. 16 of this year (see related story, p. 15). As a percentage of total application activity, refinancings rose to 35.8% from 33.4%. ARM share also increased slightly to 34.1% from 33.9%.

Fixed-rate mortgage rates dropped 20 basis points for the week ending July 9, according to Freddie Mac's latest survey. The 30-year fixed-rate mortgage rate reported in at 6.01%, and the 15-year rate was 5.42%. The one-year ARM rate also fell from its highest level this year to 4.05% from 4.19%.

Based on current rate levels, JPMorgan Securities predicts the adjusted Refi Index to fall around 10% in this week's report. Last week's pickup in refinancings should be short-lived as current 30-year mortgage rates are very familiar to borrowers, stated analysts. Lehman Brothers, on the other hand, believes the Refinancing Index will trend to the low-2000s if rates remain at current levels.

Prepay speeds in June decline less than expected

Fannie Mae prepayment speeds were not as slow as consensus predicted in June, especially the higher coupons. For example, speeds on 6.5s and 7s were expected to decline between 15% and 20%, but were down just around 10% in 6.5s and 2% to 4% for 7s. In discounts, speeds were anticipated to slow between 27% and 34% for 5.5s and 6s, but were down instead around 15% to 25%. Bear Stearns stated that forces at work in the market should make for more robust discount speeds in a higher-rate environment. JPMorgan also added that the June report should put to rest the debate regarding summer turnover expectations. In particular, JPMorgan noted, "2003 5s are benefiting from an exceptionally high home tenure (an average of more than four years prior to the refinancing) and increasing mobility due to high homeownership rates and declining transaction costs."

Ginnie Mae speeds also came in much faster than expected. In addition, lower coupons prepaid faster than conventionals and were similar in the higher coupons. Consensus had anticipated Ginnie Mae speeds in June slowing around 25% to 30% for 5s through 6s, and about 15% for 6.5s and 7s. Instead, speeds slowed 15% and less.

Fixed-rate agency paydowns totaled approximately $64 billion, a 16% decline from May. As a result, the amount of outstanding fixed-rate agency paper rose by around $15 billion, said JPMorgan. Still, net fixed-rate issuance is negative for the first half of this year. The firm expects modest growth for the second half of the year, however, with net issuance averaging around $10 billion per month.

Looking ahead, July speeds are currently projected to show modest declines from June. For example, JPMorgan estimates speeds on 2003 Fannie Mae 5s to slow to 10.5% from 11.6%, and 2003 5.5s to prepay at 15.5% versus 18.4%. As far as Ginnie speeds go, analysts expect GNMA discount speeds to be faster than experienced in 2000 and possibly faster than conventional discounts. Bear Stearns noted the following factors unique to the Ginnie Mae universe that are contributing to the faster speeds this time around: More of today's Ginnie Mae borrowers qualify for conventional financings; more aggressive pricing and competition for subprime loans; expansion by the GSEs into the Alt-A sector; and servicer buyouts.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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