In the last MBS Recap, it was noted mortgage spreads had widened an average of 16 basis points over the Wednesday-to-Wednesday period. In the latest week, spreads have weakened an additional 10 basis points. Thirty-year 7s have experienced the greatest widening as the coupon is "in-the-money" for refinancings. On the other hand, 6s experienced the least widening as investors move into that coupon and even into 5.5s to add duration and reduce convexity risk. Spread widening was primarily due to increased volatility and firm Treasurys.
Last week finally saw some of that originator supply that has been building up. Over the Friday-through-Wednesday period, mortgage banker selling totaled between $15 billion and $20 billion. While the supply was heavy, it was readily absorbed by hedge funds, money managers, mutual funds, banks, and, to a lesser extent, indexers on month-end extensions. The wider spreads, combined with the generally underweighted positions of money managers and ongoing uncertainty in equities and corporates, are all keeping mortgages well supported. For these reasons, mortgages do not have the ability to widen significantly, according to Greenwich Capital Markets. In addition, notes Greenwich, the new month tends to bring traditional positives that support mortgages: the employment report and the calendar flip.
Mortgage Indexes
Predictions for the Mortgage Bankers Association's Refi Index ranged between 3800 and 4225. Countrywide Securities added that they would not be surprised if the Index hit 4500. Refis, however, surged higher than expectations rising 35% to 4749 for the week ending July 26 as mortgage rates dropped to record lows. By type, both conventional and government refis jumped 35% to 5348 and 1584, respectively. In their August Short-Term Prepayment Estimates, Bear Stearns estimates the Refi Index needs to reach just 4200 (conventional index 4500) to match prepayment levels observed in 2001. If the Index breaks 5000, they expect speeds to be faster than observed in 2001.
As a percentage of total applications, refinancings were 67.6%, up from 61.2% in the previous report. According to the MBA, this is the highest refinancing level since November's 72.9%. The MBA also reported gains in the share of ARMs to 18.8% from 18.5%. This is the highest level since June 2000 when the ARM share reached 19.5%.
Freddie Mac announced that mortgage rates rose for the week ending Aug. 2. This was expected given the back up in rates on Monday and Tuesday. The 30-year fixed mortgage rate increased nine basis points to 6.43%. This is still below last November's low of 6.45%. Meanwhile, 15-year fixed mortgage rates gained eight basis points to 5.84%, and one year ARM rates were 4.45% versus 4.31% in the previous release. With rates holding near record low levels, refinancings should remain strong. Further gains, though not as great as last week's, are likely in this week's MBA mortgage application survey.
Supply outlook. . .
The hot topics in mortgages, of course, are increasing supply and prepayments. Bear Stearns currently estimates peak supply of $124 billion by September, which will exceed last December's amount of $118 billion assuming rates don't increase significantly over the near term. Helping to absorb the supply will be increasing paydowns. In a report last week, Lehman said they expect the largest paydown event ever. They are currently projecting at least a $63 billion paydown in the peak prepayment month versus $57 billion last December. Lehman adds that the concentration of the MBS market in 6.5s means that every one-basis-point drop in mortgage rates from current levels will cause a $1 billion increase in paydowns. And there is room for mortgage rates to fall, says Morgan Stanley.
... and prepayment outlook
As noted above, Bear believes the Refi Index - already at 4700 - needed to hit just 4200 to match 2001 peaks. Prepayments are currently estimated to hit 18% CPR for 2001 6s by September versus 8% CPR in June. 2001 6.5s are predicted to surge 147% to 37% CPR. 2001 vintage 7s are expected to jump to 49% CPR from 27% CPR; and 2000 7.5s are forecast to gain 39% to 61% CPR.
