The mortgage market saw active two-way flows last week. Good buying was noted from hedge funds, servicers, banks and arb accounts. Originator supply was less than $1 billion per day early in the week, but bankers hit the street with more than $2 billion on Wednesday afternoon as the market sold off. Over the Thursday-to-Thursday period, spreads on 30-year Fannie Maes tightened one basis point for 5% coupons; three basis points better for 5.5s and 6.5s; and seven basis points tighter for the popular 6% coupon. Meanwhile, 15-year mortgages did even better at minus four, eight and 10 basis points, respectively, for 4.5s through 5.5s.

While analysts range from underweight to positive on the sector, the majority of them are neutral. The sector remains rich, although technicals are favorable. In addition, the range-bound market favors the sector. On a near-term basis, mortgages historically have done well following the employment report and with the calendar flip.

Bank buying in MBS surges in February

A Federal Reserve report said banks took delivery of around $80 billion in MBS in February - the largest one-month increase on record, according to JPMorgan Securities. Does this mean that banks' appetite for MBS is increasing? It's not so clear, said analysts at Bear Stearns. In a recent report, analysts noted that large banks drove the increase in bank MBS holdings, increasing to $436 billion from $356 billion for the period covering Feb. 11 to Feb. 18. They also state that the "jump in holdings may simply put on balance sheet a trade that started last fall." In a 10-Q filing with the Securities and Exchange Commission (SEC) in September, Bank of America disclosed a $42.2 billion position in TBA passthroughs that was scheduled to settle as late as February, Bear said. If that happened, analysts anticipate that position alone could account for a good portion of this jump in bank holdings. Bear adds that if this pop was really the end of one very large TBA trade, it could mean bad news for mortgage spreads.

Mortgages put in strong performance in February

Mortgages outperformed Treasurys for the second month in a row. For February, the MBS Index returned 17 basis points in excess return versus Treasurys and 16 basis points versus swaps, according to Lehman Brothers. Year-to-date, excess return versus Treasurys totals 35 basis points. By coupon, the top performer in the 30-year conventional sector is 6.5s, which returned 39 basis points last month. Meanwhile, 7s are next at 34 basis points, followed by 6s at 22 basis points, 5.5s at 15, and 5s at 10. Year-to-date, 6.5s and 6s are the best performing coupons with excess returns of 67 and 57 basis points, respectively.

In the 15-year conventional sector, 6s returned 39 basis points for February; 6.5s returned 47 basis points; 5.5s returned 34 basis points; 5s returned 18; and 4.5s returned 1. Year-to-date, excess returns are 76 basis points for 6.5s; 73 basis points for 6s; 44 basis points for 5.5s; 24 basis points for 5s; and 0 basis points for 4.5s.

Compared to the other major indexes, mortgages were the No. 2 performer for both the month and year so far. For February, the ABS sector outperformed all other sectors with 27 basis points. Year-to-date, the sector leads with 58 basis points in excess return. Agencies follow with 12 basis points for the month, and 27 basis points year-to-date. Both corporates and CMBS underperformed for the month. Corporates returned negative three basis points, bringing year-to-date return down to 13 basis points. CMBS was the worst performing sector, returning a negative 10 basis points. Year-to-date return is 13 basis points. Finally, the Aggregate Index returned just 8 basis points for February, and 21 basis points year-to-date.

Refi applications increase to seven-month high

The Mortgage Bankers Association (MBA) reported modest gains in mortgage application activity for the week ending Feb. 27. On a seasonally adjusted basis, the Purchase Index was essentially unchanged at 423 versus 424 in the previous report, while the Refi Index rose 5% to 3532. On an unadjusted basis, the Purchase and Refi Indexes jumped 17% and 13%, respectively. As a percentage of total application activity, refinancings were 56.4% versus 55.7% in the previous report. ARM share rose to 28.8% from 27.1%.

Freddie Mac reported that mortgage rates held steady for the week ending March 5. The survey reported the 30-year fixed-rate mortgage rate rose one basis point to 5.59%; the 15-year fixed-rate mortgage rate slipped one basis point to 4.88%; and the one-year ARM rate was 3.47%, down three basis points. With rates holding in a narrow range, Lehman predicts the Refi Index will hold in the low-to-mid 3000s in the coming weeks.

Home prices up 8.4% in 2003

Freddie Mac reported last week that from 4Q02 to 4Q03, home values gained 8.4% (see related story, p. 18). This compares with 7.6% for the 4Q01 through 4Q02 period. The record low rates set during the year spurred refinancings and home purchases, said Freddie Mac, leading to the home price gains, particularly in the fourth quarter. Freddie Mac said that home values jumped nearly 18% nationwide in the fourth quarter, up dramatically from the third quarter's 5.9% rise. Freddie cautions, however, that these numbers are subject to revisions as they do not yet have all the data on originations.

By geographic area, the Pacific states led with an annual rate of 13.1% growth for the year. The Middle Atlantic states were next at 11.9%, followed by the New England states at 11.2%, the South Atlantic states at 8.9%, and the West North Central states at 7.1%. The West South Central states showed the slowest growth for the year at 3.9%. The East South Central, Mountain, and East North Central states were slightly better at 4.5%, 5.3% and 5.6%, respectively.

For 2004, Freddie Mac expects house price appreciation growth of 6.5%. The percentage of refi applications is expected to average 42% for the year versus 65% for 2003, while single-family originations should fall to $2.4 trillion from $3.7 trillion last year. The GSE anticipates a new record of 7.3 million for new and existing home sales to be set this year.

The Office of Federal Housing Enterprise Oversight (OFHEO) also issued its report last week, calculating a growth rate of 7.97% in home prices for the 4Q02 through 4Q03 period. For the quarter, they calculated growth at 3.67%, or an annualized rate of 14.67%. OFHEO's report showed the largest price increases occurring in Rhode Island, California and D.C. The lowest price gains were recorded for Utah, Texas and Colorado.

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