Mortgage flows were active last week despite the overhang of a Federal Open Market Committee meeting and non-farm payrolls looming. The week started off with better than expected support from month-end index buying. Also supporting the bid was demand from CMO desks, steady relative value buying as a result of the previous week's cheapening, and some fast money as well. The overall preference was down in coupon, though there was some opportunistic activity up the stack. Originator selling, meanwhile, held to a $1 billion per-day average.

Last week spreads were one basis point wider in 30-year FNMA 4.5s through 5.5s, and four to five basis points wider in 6s and 6.5s. In 15s, lower coupons were flat to slightly tighter, while 5s and 5.5s were one and three basis points weaker, respectively.

Analysts are currently mixed on the sector. JPMorgan Securities has a short-term negative view on the basis on expectations of an increase in supply with "near-term demand saturated." However, analysts remain positive longer term. Deutsche Bank Securities, on the other hand, recommends a slight overweight as mortgages remain "reasonably attractive."

Bear Stearns moved to neutral given the strong tightening recently in response to declining supply. Bear analysts are concerned that if refinancings pick up, supply might overwhelm demand. RBS Greenwich Capital also switched to neutral mid-week given the near-term events including the FOMC meeting and Friday's employment report. UBS, on the other hand, held with their mortgage overweight recommendation as analysts expect mortgages to outperform. In addition, a muted pick-up in refinance activity is expected if the market rallies towards 4% due to borrower apathy.

Mortgages outperform

in January

Mortgages are off to a positive start in 2005. JPMorgan reported that mortgages recorded 35 basis points in excess return versus Treasurys, and 24 basis points over swaps. Declining volatilities and minimal realized convexity cost drove excess returns. On a total return basis, mortgages gained 56 basis points according to JPMorgan's calculations. Also, GNMAs outperformed conventionals by 12 basis points, primarily due to strong performance in premiums.

Meanwhile, 30-years' total return was 63 basis points, with a 40 basis points excess return over Treasurys, and the 15-year sector produced a total return of 37 basis points and excess return of 23 basis points.

Currently, the largest components of the index are 30-year 5s through 6s - which represent 18%, 27%, and 13% respectively - and 15-year 4.5s, which make up 9.3% of the index, followed closely by 5s, which total 8.7%.

Lehman Brothers also reported January performance of its MBS Index. Mortgages paid 25 basis points in excess return versus Treasurys, and 19 basis points versus swaps. MBS was the second highest performing sector in January. CMBS was the top sector with 36 basis points of returns, followed by ABS at 18 basis points over, Agencies at eight basis points, and corporates at just one basis point over. The Aggregate Index recorded 12 basis points in excess return.

Refi activity jumps

in latest MBA survey

Mortgage application activity increased in the latest Mortgage Bankers Association report. This had been expected with no holidays to slow activity and slightly lower mortgage rates in the past two weeks. For the week ending Jan. 28, the seasonally adjusted Purchase Index was virtually unchanged at 440 versus 439 previously. The Refinance Index, however, jumped nearly 17% to 2254. On an unadjusted basis, the Purchase Index was up 19% and the Refinance Index gained 30%.

Mortgage rates held in a narrow range, according to Freddie Mac's Primary Mortgage Market Survey. The 30-year fixed-rate mortgage rate fell to 5.63% from 5.66% last week. In recent comments, Bear Stearns noted that mortgage refinancings could start heading up if the 30-year rate falls below 5.60%. At this level, the Refinance Index could start pushing towards the 3000 mark leading to increased supply.

Also reported, the 15-year fixed mortgage rate was unchanged at 5.14%; the 5/1 hybrid ARM rate slipped two basis points to 5%; while the one-year ARM rate rose five basis points to 4.23%.

Looking ahead to this week's MBA report, it is expected the Refinance Index will hold in the 2200 to 2300 area.

Prepayment outlook

Last Friday after press time, the housing agencies released January prepayments. Consensus saw speeds slowing around 8% on average from December's levels. Day-count for January is 20 days versus 22 days in December, according to Morgan Stanley. In addition, the lagged mortgage rate corresponding to the prepayments is around 5.74% virtually unchanged from December's 5.73% level.

In a recent report from Countrywide Securities, analysts stated that in the past couple of months, they have seen a slight decline in fixed-to-ARM refinancings. For example, in November and December fixed-to-ARM refinancings were 31%, then fell to just under 23% in January. Fixed-to-fixed refinancings were 43% in November, 42% in December, and 52% in January. Countrywide also examined the composition of fixed-rate refinancing applications by product sector. Almost all ARM loans were lower, with the exception of 10/1 hybrids, which were up slightly. Also lower were 15- and 20-year loans, while 30-years are higher.

Countrywide attributes some of the recent changes in activity to the flatter yield curve and the increase in ARM rates. Also, analysts note the strong pricing in the fixed-rate market, especially in the conforming-balance sector, is likely playing a role as well. Countrywide also suggests that there may be "a new sort of burnout, where the market is beginning to run up against the limits of how many existing fixed-rate borrowers will take out an ARM."

If this trend continues, Countrywide says implications for the ARM sector is that ARM-to-ARM refinancings become increasingly important. In the fixed rate sector, prepayment speeds on 30-year 5s and 5.5s could begin moderating.

FHLMC reports cash-out

refis in Q4 at 56%

Freddie Mac released its quarterly cash-out refinancing report last week. For the fourth quarter, 56% of FHLMC-owned loans were refinanced into new mortgages that were at least 5% higher than the original mortgages. This compares to 59% in 3Q04.

Freddie Mac Chief Economist Frank Nothaft said, "the dip in 30-year fixed mortgage rates that happened in the fourth quarter brought down the cash-out share of new refinancings even though the total share of refis went up." He expects that as interest rates increase later this year, there should be an increase in cash-out shares among refinance loans, but total dollars cashed-out are expected to be lower than in 2004.

The report also noted that the median ratio of old-to-new interest rate was 1.13, which means that half of the borrowers who paid off their original loans and took out a new one did so at, at least, a 13% higher than their new interest rate. The survey also stated that homeowners who refinanced their mortgages lowered their average rate by 74 basis points, which translates into annual savings of $885 on a $150,000 mortgage.

The median home-price appreciation for properties refinanced was 15% over the time the original loan was made. This compares to 17% for loans refinanced during the third quarter. The median age of loans refinanced was 2.2-years which was four months younger than the median age of loans refinanced in quarter three, said Freddie.

For the year, Freddie Mac expects mortgage rates to increase. By 4Q05, the rate is expected to average between 6.1% and 6.3% versus a 5.7% average in January. As a result, home sales and construction will be lower than last year, but by only 1% to 3%.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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