Last week's mortgage-backed market saw active two-way trading, with originator supply averaging $2 billion per day, primarily in 30-year 5.5s. Money managers, banks and hedge funds - taking advantage of early week widening on profit taking and adding to positions - readily absorbed supply. In addition, the week saw heavy buying in 30-year 6% coupons. In fact, that coupon tightened 16 basis points over the Wednesday-to-Wednesday period. Meanwhile, 5.5s moved out 13 basis points, 6.5s firmed three basis points, and 7s were one basis point wider. Additionally, 15s lagged 30s with 5% and 6% coupons wider by five and three basis points, respectively. Dwarf 5.5s were the best performing coupon in the sector, tightening six basis points on the week.
Overall, the Street is neutral to positive on the mortgage sector. After recent strong performance and this latest rally, profit taking and a prolonged prepayment wave could lead to near term widening. Past that, the sector continues to have very favorable demand/supply technicals. The record paydowns have to be reinvested and alternative sectors do not provide the yield or quality.
Paradoxical: Refi Index declines
The Mortgage Bankers Association (MBA) reported that mortgage applications fell for the week ending Nov. 8 despite the decline in mortgage rates. This was a surprise as most analysts were predicting an increase above the 5000 level. Researchers from Lehman Brothers attributed the poor response of the Refi Index to the decline in the premium universe, as well as burnout (see p.15).
The Refi Index declined 1% to 4826 and Purchases were down 10% to 333. The MBA also reported that, as a percent of total applications, refinancings increased to 73% compared to 70.6% in the previous report. The share of ARM activity was little changed at 13.3% versus 13.4% previously.
As expected, mortgage rates dropped substantially for the week ending Nov.15 on the latest rally in Treasurys according to Freddie Mac. The 30-year fixed rate mortgage fell 17 basis points to 5.94%, the 15-year fixed rate declined 16 basis points to 5.32%, and the one-year ARM rate hit 4.09% versus 4.15% in the previous week. All rates set new record lows. The previous record for fixed rate mortgages was set the week of Oct.11 when 30- and 15-year rates hit 5.98% and 5.34%, respectively. The previous record low on the ARM rate was 4.15% set last week.
As a result of the latest drop in mortgage rates, JPMorgan researchers expect this week's report to record a 10% to15% increase in the Refi Index.
So what's ahead for prepayments and supply?
At this point "fast prepayments are almost assured for the next three to four months," researchers at JPMorgan write, predicting speeds on new 6s and 6.5s will accelerate 15% to 25% in November despite three fewer business days. Prepayment analysts at UBS Warburg are also expecting similar increases in November with further gains in December. At this time, a leveling off is expected in January, but this latest rally is predicted to raise speeds beginning in the February report. The table below gives UBS Warburg's expectations regarding speeds over the next three months.
As for supply, JPMorgan expects volume to start increasing in December after declining for the past three months, and to be over $60 billion in the first quarter of next year when the recent paydowns get securitized.