Flows this week moved down in coupon as investors added duration on the strong flight-to-safety bid. They also responded to faster-than-expected Home Affordable Refinance Program (HARP) refinancing activity in April. 

Socialist party wins in various elections in Europe, including Greece and France, sent Treasurys higher with the 10-year note yield dipping to 1.835% by midweek from 1.88% on Friday May 4, with prices on 3.5% through 5.0% coupons recording new record highs. 

Real and fast money investors, banks, and other buyers were buying in lower coupons, with 3.5%s particularly favored. Selling was initially in super premium 5.5s and 6.0s that crept down to 4.0s through 5.0s by the latter part of the week.

Mortgage banker selling picked up as well from under $2 billion to over $2 billion as the week progressed. Overall, daily supply averaged $2.1 billion compared to $1.8 billion last week. 

The Federal Reserve, of course, continued with its voracious appetite covering 70% of the supply based on its latest report for the week ending May 9. This indicates purchases of $6.8 billion with 72% in 30-year 3.5% coupons.

The next four-week period of Fed buying will not be quite as voracious as slower prepayments in April resulted in $25 billion in paydowns available for reinvestment from $29 billion in the most recent period. 

It is still an impressive $1.25 billion per day average that would cover over 60% of originator selling on a "normal" day of $2 billion.

Contributing to the move down in coupon as trading got underway for the week was the April prepayment reports that recorded larger-than-expected slowing on 4.5% coupons and lower, while 5.5s and higher were faster-than-anticipated as a result of refinancing related to HARP 2.0. This led as well to a drop in rolls especially along 4.5s through 5.5s into Class A pool allocations as fast paying pools were delivered in. 

The outlook regarding HARP prepayments does not appear so dour, however. For example, in research this week, Credit Suisse analysts said the prepayment response under 2.0 should peak in May.

Using FHLMC Gold loan-level data for 2006-2008 origination 5s through 6.5s, they pointed to the recent prepay response of the 80-90 LTV bucket which was +5 CPR in February and 0 in April, while the 90-105 bucket declined from +6 CPR in February to +3.5 in April.

Analysts added that prepayment changes on 105+ LTVs, while increasing every month, appear to be stabilizing. Although an increase in the servicer participation rate for HARP 2.0 is a key risk to their outlook, they acknowledged that they felt that the recent Senior Loan Officer Opinion Survey corroborated their analysis of the speed changes.

BNP Paribas analysts also think that May can see the peak in HARP prepayments. They noted comments from an active HARP lender made at a recent conference saying that the firm does not expect the increased HARP volumes in 2Q12 will be sustained for long after the close of the quarter. In their research, analysts also highlighted that CR/U9 (>125LTV) originations in May have dropped from April.

While a report from Morgan Stanley analysts did not indicate the timing on peak HARP levels, what they highlighted would seem to suggest that speeds will remain in line with initial expectations following the announced changes late last year. 

For example, they don't think that lenders are shifting capacity from non-HARP loans to HARP 2.0. Instead they think originators are reallocating within its HARP capacity from 1.0 (<80 LTV) to 2.0 (>80 LTV).

While these HARP expectations seem rational, more headlines out late Thursday about government proposals might contribute to continued angst toward fuller coupons despite the low prospects of anything getting passed in the current divided Congress.

The most recent one was the official introduction by Democratic Senators Robert Menendez (D-NJ) and Barbara Boxer (D-CA) of The Responsible Homeowner Refinancing Act of 2012.

Included in the bill would be an extension of streamlined refinancings for all Fannie Mae and Freddie Mac borrowers regardless of LTV. The proposal also contain the complete elimination of upfront fees on refinancings and the elimination of appraisal costs. It also proposes the removal of barriers to competition to encourage cross-servicer refinancings and the requirement for second-lien holders to pay a fine if they unreasonably block a refinancing. The bill also brings up the expansion of HARP to loans originated between June 2009 and May 2010. 

 

In other mortgage related activity, 15s outperformed 30s in part on a more favorable prepayment profile in April, while GN/FNs were higher as they were helped by the flight to quality bid in the market. Specified trading benefited from the pressure in rolls, as well as, on continued interest in call protected paper.

 

The prepayment reports and FTQ provided a boost to MBS trading volume with Tradeweb averaging 109% through Thursday from 98% last week. MBS was not able to keep up with the rally and performance deteriorated with Barclays reporting excess return to Treasuries over the past five days at -24 basis points which brought the MTD performance to -8 basis points from +8 basis points a week ago.  The 30-year current coupon yield lowered a couple of basis points to 2.84% with the spread to 10-year notes around mid-range at +96 basis points from +98 previously. 

 

Mortgages are expected to continue to trade in a narrow range bound environment with spread weakness deemed limited over the near term. Supply/demand technicals remain strong, carry is attractive, vol is holding low, and prepayments are muted. In addition, euro zone worries have heated up again and QE3 odds are perceived to have increased, although both Credit Suisse and BNP Paribas say the QE3 probability implied by MBS remains at the lower end of its range. Still, this points "to a skewed upside and limited downside to changes in market QE expectations," said MBS analysts at Credit Suisse.   

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