The FNMA 5 roll seemed to fade into the background last week, as the market was in a waiting mode for late week Federal Reserve information on net dealer positions and bank holdings (see story p. 14). JPMorgan Securities analysts report that, given the size of the recent Mega pools, market participants are probably anticipating an increase in June bank holdings. If this isn't the case, "then it will be extremely probable that the Megas were nothing more than smoke and mirrors," JPMorgan analysts added. The squeeze could persist but it would become more and more difficult for the dealer to tolerate losses from not rolling the position. Another possibility, according to JPMorgan analysts, is that real money investors could have sold the FNMA 5s and then bought them back or swapped into Gold 5s. In this event, the squeeze in FNMA 5s "will continue to disrupt and distract" until possibly the end of the summer, according to JPMorgan analysts.

In the June monthly summaries, Fannie Mae reported a total of $25 billion 5% Megas and Freddie Mac reported a total of $20 billion 5% Giants. For the year there has been $130 billion in Gold and Mega 5s, according to JPMorgan. In addition, analysts note that the Mega production appears to exceed the float in the combined 2004 and 2005 cohorts.

Overall, activity in the mortgage market last week was directional with both real and fast money participation. The week started off with an up-in-coupon bias as the market traded off. This trade reversed Wednesday on the strong rally that was related, in part, to hedge unwinds and European economic issues. Origination selling remains, however, at its $1 billion per day average.

Mortgage applications decline as expected

Mortgage application activity declined 11% overall in response to the recent rate increase. The Mortgage Bankers Association reported that for the week ending June 17, the Purchase Index fell 9% to 479 from its record high of 529. The Refinance Index was off 13% to 2575, in line with analysts' expectations. As a percentage of total application activity, refinancings were 45.6% versus 46.4% in the previous release. ARM share was essentially unchanged at 30.7% versus 30.9%.

Mortgage rates reversed most of the previous week's gains, according to Freddie Mac's latest survey. Expectations were for rates to hold steady. Last week, the 30-year fixed mortgage rate averaged 5.57% versus 5.63% the previous week. Two weeks ago, the 30-year rate fell to 5.56 - its lowest since April 2004. Meanwhile, 15-year fixed mortgage rates were also six basis points lower to 5.16%. On the adjustable rate side, 5/1 hybrids were 5.05%, down five basis points, and one-year ARM rates reported in at 4.23%, compared to 4.25% previously. Based on the current rate levels, expectations are for the Refinance Index to hold in the mid-2000 area in this week's MBA application survey.

"Given that mortgage rates aren't expected to move too much in either direction any time soon, we fully expect the housing market will continue to thrive well into the foreseeable future," Freddie Mac Chief Economist Frank Nothaft said.

June prepays expected to increase

So far, analysts have made only minimal adjustments to their respective prepayment outlooks despite the recent spike in the Refinance Index to nearly 3000 and subsequent drop in the 30-year mortgage rate to its lowest level in a year. At this time, prepayments are expected to increase around 15% to 20% in 30-year FNMAs, and 10% to 15% in GNMAs. July speeds are expected to increase roughly 5% and August speeds are expected to rise 10% to 15%. Factors influencing the report include day count, mortgage rates and the Refinance Index. In terms of day count, there are 22 business days in June versus 21 days in May; July has 20 days; and August has 23. Freddie Mac reported that 30-year fixed mortgage rates averaged 5.72% in May, down from 5.86% in April. So far in June, rates have averaged 5.60%. Also, the Refinance Index has averaged about 2153 in May versus 1971 in April, while averaging 2635 so far in June.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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