Mortgages finally got their day in the sun on Wednesday - and not on anything that Federal Reserve Chairman Ben Bernanke said in his semiannual address to Congress. The day, in fact, was off to a rough start following weaker-than-expected earnings news from Fannie Mae, which added to the risk of a further shrinkage in its portfolio.

But then the Office of Federal Housing Enterprise Oversight (OFHEO) announced that it would lift the GSEs' portfolio caps on March 1 as both agencies published their 2007 financial statements in a timely manner (see p. 17). Both agencies must still maintain a capital level that is 30% above the statutory minimum, although the OFHEO anticipates a gradual decrease as the GSEs complete the terms of their consent orders.

As a result the OFHEO's willingness to lift the caps, FNMA 5s went from 17 ticks wider to the curve after the Fannie Mae news to over 20 ticks tighter following

the OFHEO announcement. Mortgages soared as real and fast money investors piled back into the MBS market based on expectations that the GSEs will be able to help absorb the increased supply in 2008. At midday on Wednesday, mortgages were 15 to 16 ticks tighter to the curve in FNMA 5s and 5.5s and by nine and six ticks, respectively, in 6s and 6.5s. GNMA/FNMA swaps lagged as investors swarmed to conventional products.

Prior to the unexpected the OFHEO announcement, mortgages were trading in their reactionary and "day trader" mode of late. Treasurys might have backed up as a result of the removal of risk premiums or gained ground because of inflation fears, negative home price growth and poor company earnings. Meanwhile, mortgages widened sharply as investors took profits, sold convexity and originator selling picked up.

When spreads gapped out enough, buyers such as Asian investors, money managers, hedge funds and servicers emerged. Overall through midweek, volume was slightly above normal with better buying. In other mortgage sectors, specified pools were seeing good demand from CMO desks and money managers. Meanwhile, 15s had outperformed 30s on Monday and Tuesday but were lagging on Wednesday. GNMAs were mixed with gains early in the week on credit concerns but weakening into Wednesday's session. Dollar rolls also firmed. Finally, originator selling was running at about its normal level lately, which is $2 to $2.5 billion per day through midweek.

Month to date through Feb. 27, Lehman Brothers' MBS Index is underperforming Treasurys by 139 basis points. This compares to negative 45 basis points for U.S. credit, negative 87 basis points for ABS and negative 305 basis points for CMBS. Year to date, mortgages are ahead of those cross-sectors at 156 basis points versus negative 195 basis points for U.S. credit, negative 295 basis points for ABS and negative 740 basis points for CMBS.

The Federal Open Market Committee is going to meet on March 18. Current expectations are still that the Federal Reserve will cut rates 50 basis points despite rising inflation concerns. Following Chairman Bernanke's testimony last Wednesday, Bear Stearns economists said, "With the Fed in a growth risk management mode, we continue to look for a 50-basis-point rate cut on March 18 (which is more than fully priced in after this testimony) and for two further quarter-point insurance rate cuts in April and June, putting the funds rate at 2% by midyear."

Mortgage Application Activity Drops

The Mortgage Bankers Association reported that refinancing applications plummeted, as expected, in the week ending Feb. 22 by 30.4% to 2458.9 as mortgage rates jumped. Both rates and activity are back to levels similar to those at the start of the year. At the same time, purchase activity was flat at 358.2 versus 357.6 previously.

As a percent of total applications, refinancings dropped to 52% from 61.7%. ARM share rose to 15% from 12.8%.

The MBA also reported a jump in mortgage rates with the 30-year fixed contract rate rising 18 basis points to 6.27% and one-year ARMs higher by 12 basis points to 5.84%.

Prepayment Outlook

For February's prepayment report, expectations are for speeds to surge as a result of a sharp drop in mortgage rates and a jump in refinancing activity. For example, the 30-year fixed mortgage rate averaged 5.76% in January compared with 6.10% in December, while the Refinance Index averaged 80% higher at 3838. Contributing to a small offset is a lower day count in February: 19 versus 21 days.

Current initial projections suggest that FNMA speeds will jump about 50% overall in February from January. 2007 and 2006 vintages are seen surging over 60%, while older vintages are seen gaining around 40%. GNMA speeds are seen increasing much less at around 30% overall on average. The prepayment news will be released beginning late Thursday and into Friday morning.

March speeds are currently estimated to increase 13% for both FNMAs and GNMAs, while April gains are predicted to be more moderate at less than 10%.

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

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