Last week's highlight was the government's takeover of Fannie Mae and Freddie Mac. Since the announcement was made on Sept. 7, a Sunday, it led to a sharply higher open in MBS last Monday.
It was a record-setting day in terms of price and spread gains. MBS prices surged 85 ticks on FNMA 5s, making that coupon the new current, 65 ticks on 5.5s, 41 ticks on 6s and 29 ticks on 6.5s. In Dwarfs, 4.5s soared 58/32nds, 5s 45/32nds, 5.5s 26/32nds and 6s 14/32nds. By the 3:00 marks, spreads were tighter to the curve by 88 ticks, 5.5s 66 ticks, 6s 41 ticks and 6.5s by 28 ticks. Relative to swaps, spreads ranged from 73 ticks firmer in 5s to 21 ticks better in 6.5s.
Volume was above normal with substantially better buying - particularly from the servicers and leveraged accounts, focused in the down-in-coupon trade. Profit taking was seen from banks and real money taking advantage of the higher prices. Supply averaged about $1.5 billion and consisted primarily of 5.5s.
Barclays Capital said that following Monday's move, the agency MBS universe had its duration shorten by nearly 1.1 years to three years. Based on the size of the mortgage market, this is a duration contraction of around $620 billion in 10-year equivalents, analysts said, which should help keep MBS spreads well bid.
To further demonstrate the strength of Monday's move, the Lehman Brothers aggregate index showed a complete reversal on not only month-to-date-performance, but year-to-date as well. Performance versus Treasurys went from eight basis points negative for September to 170 basis points positive in one session, and the year-to-date figure reversed from negative 68 basis points to 120 basis points in "excess returns."
Mortgages lagged on Tuesday in even heavier volume versus Monday. Following Monday's strong gains, profit taking picked up from overseas and domestic banks and hedge funds.
Opportunistic buying was noted from money managers at the afternoon wides, and servicers also continued to add. The afterglow of the GSE news faded a bit as the market refocused on the housing and market crisis. The flight to quality reemerged on news that Lehman's negotiations with Korea Development Bank firm had fallen through. The investment bank's stock plunged more than 40% and led financial stocks lower.
Credit Suisse analysts also issued a report downgrading some of the homebuilders based on concerns of further home price declines and ongoing tightness in credit standards. On the housing front, the Pending Home Sales Index for July recorded a 3.5% decline to 86.5% versus expectations of 88.6%.
On Wednesday, mortgages opened flat to weaker as the markets waited for an announcement from Lehman previewing its third-quarter earnings. The firm's earnings outlook was bleak, although Lehman said it would cut its dividend rate, spin off a large portion of its commercial real estate portfolio to shareholders and sell 55% of its investment management division. The equity market took the news favorably and turned higher, sending Treasurys lower as of midday. Mortgages started to strengthen into late morning and early afternoon as money manager and hedge fund buying offset earlier selling from servicers, overseas and originators.
In other mortgage-related activity, 15/30s were mixed, dollar rolls weakened, GNMA/FNMAs were sharply lower and specified pools saw better selling. Originator supply averaged between $1.5 and $2 billion and consisted primarily of 5.5% coupons.
Month-to-date through Sept. 9, the MBS Index was outperforming Treasurys by 115 basis points, ABS was ahead by 13 basis points and CMBS by 26 basis points, while corporates were underperforming by 30 basis points.
Mortgage Applications Gain
As anticipated, mortgage application activity was higher in the week ending Sept. 5 in response to a sharp improvement in mortgage rates. The Mortgage Bankers Association (MBA) reported that the 30-year fixed contract rate dropped 33 basis points to 6.06% - its lowest level since late May - and one-year ARM rates declined 11 basis points to 7.00%.
The Refinance Index jumped a seasonally adjusted 15.4% to 1222.9 - its highest level since mid-July. Meanwhile, the Purchase Index rose 6.4% to 371.5 - its highest since early May. As a percent of total applications, refinancing share was 36.3%, up from 34% previously. ARM share was little changed at 6.4% versus 6.6%.
Further improvement in mortgage rates occurred last week following the government's takeover of the GSEs. This is expected to spur activity. In a report released on Monday, JPMorgan Securities analysts said that 30% of the mortgage universe has a 50 basis points or more incentive. As a result, analysts are looking for the Refinance Index to double - moving into the 2000 to 2500 area. They said that another 50-basis-point rally will give 60% of the universe a 50-basis-point or more incentive. Analysts noted the last time this happened was in January of this year, which moved the Refinance Index above 5000.
The prospect that the GSEs can modestly grow their portfolios and that the government will begin buying MBS later this month, and the need for convexity hedging are certainly positive for mortgages. At the same time, Asian investors have been disappointing in their response so far following the GSE takeover. In fact, the question of who the marginal buyers are has led UBS MBS analysts to downgrade their MBS allocation to neutral as mortgage-backeds appear to be more fully priced. Additionally, the housing/credit crisis is not over, and headlines and data are sure to disappoint and keep investors edgy.
Prepayment Outlook
Speeds in September are projected to be lower by 5% in Fannies and by 2% in GNMAs. Contributing to the decline is lower refinancing activity in August, as well as higher mortgage rates. The Refinance Index averaged 1052, down 18% from July's average. At the same time, the 30-year fixed mortgage rate averaged 6.48%, off five basis points from July's average. Day count holds steady in September at 21 days.
According to Bankrate.com, the 30-year fixed mortgage rate averaged 5.79% as of Sept. 10, down 46 basis points from the previous week, following the GSE takeover. As a result, speeds are projected to surge 25% to over 30% in October, with the largest percentage gains seen in 2007 vintages. However, speeds will turn modestly lower in November as a result of slower seasonals and five less collection days compared with October.
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