Mortgage spreads widened last week with the cusp coupons weakening 10-12 basis points and the wings moving out six to eight basis points. The weakness stemmed mostly from limited buying interest as the previous week saw strong month end buying. On top of that, the mortgage sector recorded an excellent first quarter performance. According to Lehman Brothers, MBS has generated 114 basis points nominal year-to-date return and 155 basis points excess return.
On top of the buying pause, originator selling was heavy at the beginning of the week with about $2 billion on Monday. Mortgage bankers came with limited supply over the remainder of the week, however. With mortgage rates higher, the Street believes pipelines are fairly light and expect production to wane in the weeks ahead. This outlook bodes well for the sector as demand remains strong, the carry is excellent, and based on recent comments from Fed officials, rates look to be rangebound.
The spread widening encouraged better buying towards the latter part of the week particularly from money managers, hedge funds, and banks. Arb accounts were noted as better sellers on profit taking. This is likely to continue this week. In addition, this week's activity will be dominated by roll activity. Tuesday begins 48-hour notification for 30-year conventional MBS, and for 15-year MBS on Friday.
Mortgage Indexes
The Mortgage Bankers Association reported that overall mortgage applications declined for the week ending March 29 despite mortgage rates holding steady. This was not unexpected given the Passover and Easter holidays. The Refi Index fell 12% to 1272. As a percentage of total applications, refinancings dropped to 35.9% from 40.2% in the previous release.
The Purchase Index, meanwhile, rose 6% to 350. Salomon Smith Barney notes that the Purchase Index is about 20% ahead of last year's levels. This suggests to them that housing turnover may reach record levels this year.
In comments from Lehman, they said not to read too much into the data due to the holiday-shortened week. Still, with the Refi Index down 46% since the beginning of March, speeds are expected to be sharply lower by late Spring. For example, Lehman now projects 2000 conventional 7s and 7.5s to prepay at 35% and 46% CPR, respectively. This is 10-12% CPR lower than February levels.
Freddie Mac reported that mortgage rates dipped slightly for the week ending April 5. Both the 30- and 15-year fixed mortgage rates fell five basis points to 7.13% and 6.64%, respectively. Meanwhile, the one-year ARM rate dropped to 4.99% from 5.11%. The decline suggests that this week's MBA Refi Index could hold flat or increase slightly. CS First Boston also adds that the Good Friday delay could have passed over into last week.
Prepayment outlook
On Friday, April 5, the housing agencies released prepayment data covering the month of March. The data came out too late to be included in this week's Asset Securitization Report, but it will be reviewed in next week's issue.
Looking ahead to the April report, conventional speeds are predicted to be flat to slightly lower, and in May, estimations range from flat to about 20% slower with 8s and 8.5s declining 5-10%. By June, Bear Stearns expects to see prepayments to slow from current levels by an average of 30% on coupons above 6.5%.
