Last week, mortgages struggled on the return of negative subprime and housing news that led to a flight to quality bid in Treasuries, and a sharp uptick in volatility. Increasingly disturbing news regarding the housing market has increased the odds that the Fed will cut rates 25 basis points at the end of October. Odds are currently 44% of a 25 basis points cut, up from 32% on Wednesday, October 10. Further adding to the market's strength on Wednesday was news that Turkey's parliament had approved moving more troops into northern Iraq. From Friday, October 12, close through mid-day Wednesday, October 17, the 10-year Treasury had rallied 33/32nds, the yield was down 13.3 basis points to 4.552%, the 2-year Treasury note yield had plummeted 23.1 basis points, and the 2s10s curve was steeper by 9.8 basis points to 55.7 basis points.

The market conditions brought out better selling/profit taking in mortgages from real and fast money -focused in 5.5s and 6s, although the widening periodically attracted buying interest. Overseas was mixed, but they took advantage of wider spreads. Originator selling averaged between $1 and $1.5 billion per day in the first half of the week. Supply continues to be primarily in 6% coupons.

Ginnie Mae finally ruled on how it would securitize FHA Secure loans: they will trade in a new, multiple-issuer pool type under the Ginnie II program and designated "G2MFS". While seen as favorable that they are not TBA deliverable, there wasn't much of a positive response in the GN/FN swaps. In fact, Ginnies slightly underperformed Fannies on Tuesday as the market digested the news. While the news was favorable, the swap had recently outperformed in anticipation of Ginnie's decision, and so apparently there was a little bit of "selling the fact" taking place.

MTD through Tuesday, October 16, excess return on Lehman Brother's MBS Index is +39 basis points, down from +50 basis points through October 12. Still the sector is leading ABS and CMBS, which are outperforming by +20 basis points and +22 basis points, respectively. The sectors are lagging corporates which are up 85 basis points so far this month.

Latest Housing/Credit News

The government reported housing starts dropped 10.3% in September and the number is at its lowest level since March 1993 at 1.191 million (AR) units. In addition, August numbers were revised to -3.2% from -2.6%. Economists were expecting starts at 1.3 million units. Building permits fell by 7.3% in September, which was the largest 1-month drop since January 1995.

* The National Homebuilders Survey reported its sentiment index fell for the 8th straight month and to a record low. Its two other measures, index on expected sales and index on traffic, are sitting at record low levels as well.

* Both Federal Reserve Chairman Benjamin Bernanke and Treasury Secretary Henry Paulson expressed concerns about potential risks to the economy's growth as a result of the housing slump.

* Standard & Poors downgraded $4.6 billion subprime RMBS issued in 2005, and $23.35 billion in subprime RMBS issued in the first half of 2007.

* Several large banks including Wells Fargo, KeyCorp, and Citigroup Inc. reported lower than expected earnings results due to credit issues.

08 Conforming Loan Limits

Last week, the OFHEO released a press statement stating that there would be no decline in the 2008 conforming loan limit, and that they were seeking additional comments on revised loan limit guidance. Regarding the conforming loan limit for 2008, the regulator said that if the relevant home price index for 2007 declines, than the conforming loan limit would stay at $417,000 next year. If there is gain, the limit would remain either unchanged -if the increase is less than or equal to last year's decline, or if large enough, be netted out between last year's decline and this year's increase.


In the Treasury market, 2- and 5-year note announcements are made on Monday with auctions scheduled for Wednesday and Thursday, respectively. On Tuesday there is a 5-year TIPs {reopening) auction.

In research last week, analysts were generally neutral to negative primarily of increasing supply. UBS, for example, says that while mortgages look fairly valued on their regression models and cheap via OAS, supply is quite heavy and they believe there are better opportunities in other sectors of the mortgage market such as non-agency pass-throughs, agency CMOs, and hybrids. Barclays Capital says it is neutral near term, but remain more bearish longer term due to higher supply and slowing prepayment speeds. JPMorgan Securities, meanwhile, recommends an underweight on concerns related to supply pressure, extension risk and uncertain demand. They are currently projecting net fixed rate agency issuance will hit a record $450 billion this year, and $533 billion in 2008.

Mortgage Apps Up

Application activity was little changed for the week ending October 12 as mortgage rates held steady. The Purchase Index rose 2.1% to 429.1, while the Refi Index declined back below 2000 to 1980.9, down 1.1% from the previous report. As a percent of total applications, refinancing share was 45.3%, down from 46.2%. ARM share was little changed at 13.5% compared to 13.6% previously.

After declining in September, speeds are anticipated to recover to some extent in October as day count increases from 19 to 22 days. In addition, the period covers a more favorable rate environment and higher refinancing activity. For example, in September the 30-year fixed mortgage rate averaged 6.38%, down from 6.57% in August according to Freddie Mac. Meanwhile, the MBA's Refi Index averaged 1954, up 7% from August's average. This should be more of an impact on premium coupons.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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