As the market initially strengthened at the start of last week and then began to sell off on Wednesday, MBS participants were generally better sellers, with flows directed up in coupon. Asian investors were again on the quieter side as yields moved toward 5% on the 10-year Treasury. On a positive note, however, originators were relatively light, averaging around $1 billion to $1.5 billion per day, down from more than $2 billion in recent weeks. Overall, volume was slightly below normal into midweek.

One pierce of excitement on Tuesday was good support for 30-year Gold 6%s and 6.5%s. Apparently, the latter benefited from hedge fund buying in anticipation of continued buying from Asian investors, while the former was helped by a deal bid.

Subprime also reared its head again last week with news that Bear Stearns might have to liquidate two hedge funds as managers have been unable to negotiate an acceptable rescue plan.The hedge funds contained subprime mortgages whose values had been deteriorating on increasing credit concerns. This apparently was contributing, at least to some extent, to buyers staying near the sidelines despite yields rising on Wednesday.

The Lehman Brothers MBS Index showed mortgages to be the worst performing sector so far in June versus ABS, CMBS and corporates. For the month through June 19, the MBS Index has returned negative 18 basis points versus Treasurys; ABS are at negative three basis points; CMBS are up five basis points, and corporates are at a negative 10 basis points.

Mortgage Outlook

The last week of June has a full calendar of data, though not necessarily the top-tier kind. In addition, the Federal Open Market Committee meets for two days beginning Wednesday, June 27. Economic releases include: existing home sales on Monday next week; new home sales and consumer confidence on Tuesday; durable goods on Wednesday; the final first quarter GDP reading on Thursday; and Personal Income and Outlays, Michigan Sentiment and Chicago PMI on Friday. Also, the Treasury has a two-year note auction scheduled for Tuesday, followed by a five-year note auction on Wednesday. In addition, next week is also month-end, and index buying is likely to show up later in the week, particularly on Friday.

The recent dramatic selloff that moved the 10-year Treasury above 5% has improved the outlook on MBS, said Lehman in a recent report. Analysts said there are several reasons to be optimistic on the sector, including reduced convexity risk, lower fixed-rate supply, and attractive current valuations for yield-based investors.

On the other hand, Barclays Capital analysts remained concerned about downside risks over the next few weeks. They expect the upcoming economic releases to report on the strong side, which will likely cause rates to increase. Mortgages should do better, they said, if rates hold steady, but they believe bank selling of discounts is a significant risk. They have an up-in-coupon preference as they expect yield buyers to support higher coupons. In addition, housing continues to show weakness.

Mortgage Application Activity Drops

As expected, the Mortgage Bankers Association reported that application activity declined in the week ending June 15 as rates jumped sharply. During that week, Freddie Mac reported 30-year fixed rates at 6.74%, up 21 basis points from the previous week. The Refinance Index was down 4.2%, to 1776.8, while the Purchase Index slipped 3%, to 450.9. This marks the fourth straight week that the Refinance Index has held below 2000. A year ago, both indices were at 1356 and 396, respectively, with the 30-year mortgage rate at 6.63%.

As a percent of total applications, refinancings were unchanged at 38%, the MBA said, while ARM share increased again to 20.3% from 17.3%. The MBA also reported the average contract rate for 30-year fixed-rate mortgages was little changed at 6.60%, versus 6.61% in the previous survey.

Prepayment Outlook

Speeds in June are expected to hold nearly unchanged in 6% coupons and lower, while 6.5s are predicted to slow around 5% from May. Slightly stronger seasonals were seen as an offsetting factor to the lower day count. Declines of around 10% on average are expected for July prepayment speeds. Day count holds unchanged at 21 days for the month. However, higher interest rates and the decline in application activity are expected to have a significant impact on prepayments. In August, speeds are projected to be around 5% higher than in July as the number of collection days increases by two, to 23.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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