Mortgages have been on a tear since the start of 2003. Banks, CMO desks, insurance companies and money managers have all been heavy buyers. Spreads in Fannie Mae 30-year 5.5s through 7s have tightened an average of 18 basis points since the start of the year, while Dwarfs are 14 basis points firmer. Analysts at RBS Greenwich Capital believe that the strength in 30s is most likely due to technicals. Further, they believe this will dominate fundamentals over the short run, and until the yield curve begins to flatten and the Fed starts to raise rates. As a result, says Greenwich analysts, while "mortgages have moved very quickly to tighter valuations so far in 2003, we do not feel that this means that investors have missed the boat if they have been uninvolved so far."

Roll-related trading was also a dominant theme last week. Rolls on Fannie Mae 5.5s and 6s were trading through fail all last week as 48-hour notification for 30-year conventional MBS approached due to the limited supply situation.

Originator selling was strong out the gate as well. Over the first three trading days of 2003, mortgage bankers brought over $20 billion in supply. Since then, supply has been limited to the $1 billion area.

Refi Index jumps as mortgage rates set record lows

Despite the New Year's holiday, mortgage applications moved higher for the week ending Jan. 2 as mortgage rates set a new record low of 5.85% during that week. According to the Mortgage Bankers Association (MBA), the Refi Index jumped 29% on a seasonally adjusted basis to 5871, and soared 51% to 4110 on an unadjusted basis. At the same time, the seasonally adjusted Purchase Index gained 13% to 376, and was up 35% to 202 on an unadjusted basis.

The MBA also reported that refinancing applications as a percent of total applications rose to 77.8% from 75.9%. This is just under last year's high of 78% reached for the week ending Oct. 16. The record high is 78.4% set for the week ending Nov. 9, 2001. The MBA also reported that the share of ARM activity increased to 13.4% from 12.5%.

As expected, mortgage rates came off their record low levels, according to Freddie Mac. For the week ending Jan. 10, 30-year fixed rate mortgage rates rose 10 basis points (less than expected) to 5.95%; the 15-year fixed mortgage rate gained nine basis points to 5.33%; and the one-year ARM rate came in at 4.03% versus 4.06% the week prior.

December prepayments rise in-line with consensus

Fannie Mae speeds increased about 5% on aggregate and were in-line with consensus expectations. While the refi index for the period covered was lower versus November speeds, the daycount was 21, according to JPMorgan Securities researchers, versus 19 in November. This contributed to the slight rise for the month. Several firms were predicting declines for December and were apparently tripped up by the daycount number.

Freddie Mac speeds increased less than Fannie speeds in December. According to analysts at Lehman Brothers, certain Fannie Mae servicers recorded large increases while there were no such dramatic differences among servicers in Freddie Mac pools. Lehman believes that some Fannie servicers chose to accelerate closings in December. According to Lehman researchers, FNMA servicers have to pay compensation to investors from the closing date to the end of the month. As a result, they have an incentive to plan closings at the end of the month, said Lehman analysts. Freddie servicers do not have that requirement.

Looking ahead to January's report, JPMorgan expects modest slowing of only 2% to 5%. This is in line with consensus expectations at this time. JPMorgan expects the decline will be limited on the belief that many closings were delayed until January due to the holidays. January also has the same daycount as December.

The impact of the recent record low rates will be felt in the March report. Currently, UBS Warburg researchers are projecting Fannie speeds in March to be similar to the December report.

Ginnie Mae speeds were also in line with consensus expectations for the most part. Speeds on unseasoned 6s through 7s rose around 10% from November, slightly more than Fannies. Ginnies were lagging in October and November as originators concentrated first on the easier to refinance conventional loans. The more seasoned 7% and 7.5% vintages, however, prepaid more slowly than expectations and were essentially unchanged from November speeds. The older vintages and higher coupons were predicted to increased about 5%. In comments from UBS Warburg, analysts believe the lack of response is most likely due to a drop in cash-out refis and a longer lag.

Looking ahead, consensus is currently calling for a decline of about 5% in January and 10% in February.

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