Through mid-week, MBS trading was lackluster given the GSE headlines and the lack of economic data. Flows were two-way, but favored better selling on the lack of direction. Activity, however, came from a wide range of domestic investors - real and fast. Investors were generally moving up in coupon or into 15-year MBS. On Thursday, active buying emerged, particularly in the lower coupons, on a combination of March prepayments and the start of roll-related trading associated with the upcoming settlement in 30-year conventionals. Meanwhile, originator selling averaged about $1 billion per day.
Analysts are currently mixed on the sector. Technicals remain very favorable - especially due to overseas support which has some analysts neutral to slightly overweight. A further boost for potential Japanese support came last week when the Ministry of Finance issued some guidelines for foreign reserves. Citigroup Global Markets analysts said foreign asset diversification into various bonds is encouraged, including securitized bonds that have high liquidity and certainty of redemption.
Analysts that are slightly negative on the sector fear that spreads are too rich for the current risk levels. Bear Stearns, for instance, enumerates risks currently facing the MBS market, including continuing negative Fannie Mae news, neutral bank demand, low levels of implied volatility and historically tight OAS.
Mortgage application activity slips
The Mortgage Bankers Association reported a slight decline in application activity for the week ending April 1. The Refinance Index was down 3% to 1799 - in line with analysts' expectations - while the Purchase Index declined 5% to 446. As a percentage of total applications, refinancings were 38.3%, up from the previous release's 37.8%. Meanwhile, ARM share declined to 35.2% from 36.6%.
Mortgage rates fell moderately as a result of the recent rally in rates. Freddie Mac's latest survey reported 30-year fixed mortgage rate declined 11 basis points to 5.93% for last week. The 15-year fixed rate was down 10 basis points to 5.48%, and 5/1 hybrid ARMs and one-year ARM rates were 10 basis points lower to 5.33% and 4.23%, respectively.
Looking ahead to this week's mortgage application activity report, expectations are for the Refinance Index to hold steady.
FNMA prepays up stronger than expected
March prepayments surged in response to the February decline in mortgage rates, a higher day count and seasonal factors. Consensus estimates were for conventional speeds to jump around 25% to 30%; however, speeds increased much more. Speed increases were even stronger for FHLMC MBS. The largest percentage increases were for 2004 vintages with FNMA 5s gaining 45% and Golds surging 70%; and 5.5s jumping 49% and 53%, respectively.
The report should benefit lower coupons on expectations that extension risk is contained, reported analysts at Credit Suisse First Boston. At the same time, higher coupons would probably not be negatively impacted by the increase. Lehman Brothers says that since the prepayment increase in March was due to strong seasonal turnover and a higher day count, and since the higher rates seen in March would have caused a larger proportion of February applicants to close successfully, there is no real increase in callability in this sector.
As noted, percentage increases in Golds were stronger than FNMAs. Speeds are now similar for many coupons and vintages. Previously, Bear Stearns attributed the difference in FNMA and FHLMC prepayments to Fannie Mae pools having a higher percentage of loans with non-standard borrower characteristics. Given that, analysts expected that if rates were stable or sold off, Fannie pools would tend to outpace Freddie Mac's, while a rally would tend to cause speeds to converge.
Paydowns totaled roughly $63 billion, according to CSFB. Looking ahead to the April report, speeds are seen declining as a result of the increase in mortgage rates and a slightly lower day count. Since mid-February, the MBA's Refinance Index has declined 30% while 30-year fixed mortgage rates have increased 47 basis points. Lehman expects speeds on premiums to remain fairly muted over the near term due to reduced fixed-to-ARM refinancings, while discounts should remain somewhat elevated on the continued strong housing market and purchase activity. JPMorgan Securities currently projects speeds to decline around 6% in April. Specifically, analysts estimate 2004 Fannie 5s to prepay at 12.5 CPR, 2003 5s at 15, 2004 5.5s at 19 and 2003s at 22.5.
Prepayments on GNMA MBS were mostly in line with expectations. This is not surprising, as mortgage brokers tend to target the easier to refinance conventional borrowers first on rate rallies. Still, speeds in the sector remain faster than their conventional counterparts. The lag suggests that GNMA speeds next month may not fall as much as conventionals.
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