Last week got off to a slow start as many participants extended the long Memorial Day weekend into Tuesday.

Volume was significantly below normal, though mortgages did relatively well (about even to swaps and modestly underperforming the curve) under a huge Treasury sell-off (-23/32nds on the 10-year Treasury bringing the yield to 3.92%), wider swap spreads and higher volatility.

In particular, hedge funds were reportedly better sellers, focused primarily in 5.5% coupons. Overseas and real money investors were better buyers as a result of the cheaper dollar prices, with interest in 5.5s and 6s. Meanwhile, supply was minimal at about $1.3 billion on the day.

A much stronger-than-expected durable goods report sent Treasurys tumbling again with the 10-year Treasury down 20 ticks by mid-day on Wednesday and the yield at 4%. Mortgages, however, were not seeing the supportive flows experienced in the previous session. Mortgage-backed volume did pick up partly because of fast money selling, especially in 5% coupons, along with originator supply said to be over $1 billion. Spreads significantly lagged both the curve and swaps.

In other mortgage activity, relative value showed strong interest in the first half of the week in 15-year MBS. In terms of specified pools, 10/20 IO 6.5s were seeing good demand from CMO desks, and GNMAs also were seeing decent demand, particularly from overseas.

Month-to-date through May 27, Lehman Brothers' MBS Index was outperforming Treasurys by 33 basis points as well as the Credit Index, which was up just seven basis points. ABS and CMBS were the better performers at 95 basis points and 183 basis points, respectively.

Year-to-date, the MBS sector retains a strong lead, however, up 55 basis points compared to negative 455 basis points for ABS, negative 228 basis points for CMBS and negative 165 basis points for credit.

Housing News Remains Daunting

New home sales for April actually rose 3.3% to an annualized rate of 526,000 according to the National Association of Realtors. However, the gain came on a sharp downward revision in March to 509,000 from an originally reported 526,000.

Year-over-year, new home sales are down 42%. Inventories declined to 456,000 from 467,000; months' supply is 10.6-months, improved from 11.1-months in March. Also reported was a 1.5% increase in the median price of new homes to $246,100 from a year ago. Bear Stearns' economists said that there was little to suggest "the beginnings of stabilization in the housing market" as sales only rose to the originally reported level for March. Furthermore, the data doesn't capture any effects of cancellations, and inventories remain high relative to sales. They also noted stiff declines in home prices as reported by the Standard & Poor's/Case-Shiller indexes.

S&P/Case-Shiller reported sharp declines in home prices in both its 20- and 10-city indexes for the month of March, as well as for the first quarter. Year-over-year, the 20- and 10-city indexes declined 14.4% and 15.3%, respectively. These were both new record declines. Over the month, prices fell 2.2% for the 20-city index and 2.4% for the 10-city index. Also, a new record was a 14.1% decline in the first quarter compared with a year ago in the U.S. National Home Price Index.

The report noted that in the housing recession of 1990-1991, the annual rate bottomed at a mild -2.8%. "There are very few silver linings that one can see in the data," said David Blitzer, chairman of the Index committee at S&P. Most of the nation appears to remain on a downward path, with 19 of the 20 metro areas reporting annual declines, and six of those now at negative rates exceeding -20%." He noted that monthly data showed declines in 18 of the 20-metro areas for the seventh consecutive month.

Two cities reported appreciation for the month: Charlotte (0.2%) and Dallas (1.1%). The weakest markets were Las Vegas (-25.9% annual decline), Miami

(-24.6%) and Phoenix (-23%). Charlotte is the only city that has experienced year-over-year growth of +0.8%.

RBS Greenwich Capital's economists looked a bit harder for some positives in the report and noted that March's 2.2% decline was less than February's 2.6% drop, and also that the declines in the 18 metro cities were less than in February.

Mortgage Outlook

Analysts' tone remained in the neutral to positive area last week. Credit Suisse analysts said they are staying neutral on the MBS basis for the near term, while their longer-term outlook is positive. On the shorter view, one reason is the upcoming quarter end for brokers, which could potentially reduce appetite for cash positions, they said.

Longer term, they noted better GSE participation as a result of the easing in their portfolio and capital surplus constraints and the potential for the housing legislation to reduce foreclosures.

Barclays Capital analysts retained their overweight recommendation on the agency MBS basis, as they believe there is still room for spreads to tighten. Factors supporting their view include the low volatility expectations as the Federal Reserve has apparently finished its easing cycle; improved liquidity as a result of the Fed's initiatives; the return of the GSE as a backstop; lower conventional supply concerns as Federal Housing Administration (FHA) lending has picked up considerably; and expectations for further tightening in swap spreads.

Mortgage Applications Declined

Mortgage application activity declined in the week ending May 23 in response to higher rates and likely holiday-related slowing - not to mention the effects of the tighter lending standards along with lower consumer confidence. In fact, the most recent Conference Board's Consumer Confidence Index declined to a 16-year low with respondents increasingly concerned about job conditions. Consumers' plans to buy an automobile or home also decreased. The most recent Senior Loan Officer Opinion Survey released in early May reported tighter credit standards in the past three months for mortgage loans including prime loans. Both do not bode well for the near-term outlook for a meaningful pick-up in application activity.

The Mortgage Bankers Association (MBA) reported that the Refinance Index fell 8.9% to 2013.5, while the Purchase Index was essentially unchanged at 352.7 compared to 352.5 in the previous week. The 30-year fixed contract rate held below 6%, but gained six basis points to 5.96%.

Meanwhile, the one-year ARM rate jumped 21 basis points to 6.92%. As a percent of total refinancings, the refinance share declined to 46.1% from 48.2%. ARM share was also slightly lower as a result of the higher ARM rates at 9.3% versus 10.0% in the last report.

Certainly the prime spring season has been disappointing for the housing market with the continued weakness in home sales, starts, along with further price erosion in most areas of the country. It is unlikely the early summer season will bring much relief either given the housing market conditions, low consumer confidence and tight lending standards. One potential positive could be passage of housing legislation - at least for helping troubled borrowers refinance into a new FHA loan and possibly reduce the level of foreclosures, which adds to the housing supply and negative pressure on home prices.

Prepayment Outlook

Speeds are currently predicted to slow to about 1-2% in May with the 2007 and 2006 vintages continuing to experience the largest percentage declines. Contributing factors include one less collection day in May versus April and lower refinancing activity on average. The MBA's Refinance Index averaged 2411 in April compared to 2919 in March.

Looking ahead to June and July, speeds are expected to increase just 1% to 2% on conventionals and slightly more for GNMAs, helped by seasonals and steady to higher day count (21 days in June and 22 in July).

Mortgage Indexes

FH 30Yr

Fixed

Wk Refi Purchase Mortgage

Ending Index Index Rate

05/23/08 2014 353 5.98%

05/16/08 2211 353 6.01%

05/09/08 2422 379 6.05%

05/02//08 2274 381 6.06%

04/25/08 1905 340 6.03%

04/18/08 2286 357 5.88%

04/11/08 2866 382 5.88%

04/04/08 2725 385 5.88%

03/28/08 2636 356 5.85%

03/21/08 4255 404 5.87%

03/14/08 2335 365 6.13%

03/07/08 2448 369 6.03%

02/29/08 2569 363 6.24%

A Year Ago 1875 427 6.37%

Source: MBA, FHLMC

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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