Last week the market continued to see strong originator selling, though not to the level seen in the previous week - roughly $15 billion versus $30 billion. Despite the recent heavy supply, analysts from JPMorgan Securities remind the market that 30-year net production remains negative, and with reinvestment of heavy paydowns, spreads are likely to hold firm and tighten.
Investor activity was mixed, starting the week off quietly on the threat of war, and picking up as the week progressed. Banks, money managers and CMO desks remained the primary sources of support. Over the Wednesday-to-Wednesday period, spreads on 30- and 15-year discounts tightened 10 basis points on prepayment concerns. Cusp coupons were one to four basis points firmer.
In other news, the Fannie Mae and Freddie Mac have closed their April CMO shelves. In comments, the GSEs cited the need to ensure liquidity in the MBS market and to avoid a short squeeze.
Refi Index breaks previous week's record
For the week ending March 14, mortgage applications continued to rise as rates held in record low territory (see related story on p. 1). The Purchase Index gained 0.7% to 347.3, while the Refinancing Index increased 5.2% to 9387.0, according to the Mortgage Bankers Association (MBA). As a percentage of total applications, refinancings set a new record at 80.5%, breaking the previous week's record of 79.8%. The ARM share also rose to 12.8% from 11.4%.
This week's Refinancing Index is expected to decline as rates have spiked. Freddie Mac reported that mortgage rates increased for the first time since mid-January for the week ending March 21. Both the 30- and 15-year fixed mortgage rates jumped 18 basis points to 5.79% and 5.11%, respectively. Meanwhile, the one-year ARM rate gained seven basis points to 3.75%.
As a result of the increase in mortgage rates, analysts expect the Refinancing Index to fall next week. Salomon Smith Barney analysts expect the index to decline to 5000 to 6000 over the next couple of weeks. Meanwhile, JPMorgan analysts predict the index to decline to 6500 to7000 as early as this week.
Impact of record low rates and record high refinancings
In a recent report from Bear Stearns, analysts quantify the impact of current rate levels on the MBS market in terms of supply, prepayments, as well as coupon distribution. They note that 89% of the MBS universe, or $2.5 trillion, is exposed to a refinancing incentive of 40 basis points or more. On the supply front, they estimate total mortgage originations in the first quarter to hit $827 billion, and jump to $1.2 trillion in the second quarter. For the year, they project total mortgage originations at $3.3 trillion versus $2.5 trillion in 2002.
Fannie Mae's economists are now predicting mortgage originations to hit a record $3.2 trillion, up dramatically from their last estimate of $2.15 trillion. Of that number, $2.2 trillion is expected to be made up of refinancings.
In terms of peak prepayment speeds, analysts from Bear estimate 2002 5.5s hitting 25% CPR, 2002 6s reaching 54% CPR, and 2002 6.5s prepaying at 76% CPR.
The effect of the high level of paydowns and increasing supply in lower coupons is a significant transformation of the MBS universe. Currently, 5.5% coupons make up about 15% of the 30-year universe, but by the middle of 2003, Bear Stearns projects the percentage at approximately 27%. Meanwhile, 5% coupons (which make up less than 1%) should top 5%; 6s (which represent 30%) will hold near that level; and 6.5s will fall below 25% from about 33% currently.
As a result of the falling gross weighted average coupon (WAC) in the mortgage universe, researchers from Bear Stearns talk of the increased extension risk in the MBS market. In addition, they warn investors that the duration skew will be more extreme when the downtrade begins in earnest.
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