Mortgage activity was focused primarily on rolls last week as 48-hour notification began on Tuesday for 30-year conventionals. The Fannie Mae 6% roll to carry collapsed, while 6.5s came to a tick plus below fail. Salomon Smith Barney notes that the July/August 6.5 roll is already trading at nearly two ticks over carry; however, they don't believe the roll will get as hot as it did this past month.
Buying activity came mainly from money managers, reinvesting paydowns, and hedge funds. With yields lower, the focus was in 6s and 6.5s on outright buying and moves down-in-coupon. Banks and arbitrage accounts were quiet on the week. Originator selling was limited and less than the $1 billion plus per day seen in the previous week. Overall, spreads were essentially unchanged over the Wednesday-to-Wednesday period.
Street analysts are mostly neutral to overweight the mortgage sector. As noted by Morgan Stanley, there have been several encouraging developments including: (1) a range-bound market in terms of rates and volatility; (2) attractive carry that should continue to drive investor demand; (3) convexity and prepayment risks that are likely to remain moderate until rates break substantially out of their current range; and (4) mortgage valuations which have improved as a result of recent underperformance.
The spread widening over the past few weeks has attracted investors back. According to JP Morgan's latest MBS Client Survey, the share of overweights increased by 12.9% to 33.3% while the share of neutrals fell 10.4% to 38.6%. As a result, investors are now slightly overweight the sector compared to a moderate underweight in the May 29 survey.
May prepayments
The Fannie Mae prepayment report generally came in as expected with unseasoned 6s through 7s holding flat to increasing, and higher coupons showing declines in the range of 10-20%. Specifically, 2001 6s jumped 22% to 7% CPR, 6.5s gained 3% to 13% CPR, and 7s were unchanged at 24% CPR. Moderate to fully seasoned 6.5s and 7s slowed 10% to15%. In 7.5s and 8s, unseasoned issues slowed about 2%, while most older vintages also declined in the 10% to 15% range.
Looking ahead to June prepayments, Salomon Smith Barney expects speeds to be mostly flat as a lower day count should offset recent gains in the Refi Index. Bear Stearns, on the other hand, expects speeds to reverse as they believe mortgage rates that will apply to the report will be about 6.84% versus 7.05% for the May report.
While the conventional prepayment report was as expected, the Ginnie Mae prepayment report was surprisingly strong. The aggregate monthly change in Ginnies versus conventionals was: 6s: 10% -7%; 6.5s: 3% versus -9%; 7s: 1% versus -8%; 7.5s: flat versus -10%; and 8s: -2% versus a decline of 8% in the previous period, according to Salomon.
Salomon suggests the reason for the difference between conventionals and governments is that government loans tend to close at the end of the month rather than spill over into the next month. Another possibility is buyout activity, which is not reflected in the MBA's Mortgage Application Indexes.
Given the relative strength in Ginnies versus conventionals for the last two reports, Salomon expects Ginnies to be weaker in June.
Mortgage Indices
The Mortgage Bankers Association (MBA) reported mortgage applications were mixed on a seasonally adjusted basis for the week ending June 7. The Refi Index rose 6% to 1694 while the Purchase Index dropped 13% to 359. On an unadjusted basis, however, the Refi Index surged 33% and the Purchase Index gained 7%. Overall, mortgage rates remained little changed. According to the MBA, the 30-year contract rate fell one basis point to 6.65%.
In comments from Lehman Brothers, they noted that at current rates, they would expect the Refi Index to be near 1900. They say the implication of the index holding lower is that premium prepayments on 2000 and older vintages will be substantially lower in July relative to April.
