Mortgage activity was mixed last week after a quiet start. There was no meaningful data released until Wednesday's Federal Open Market Committee's statement. In general, however, the tone remained relatively supportive as the market was range bound and Asian investors were back from their week long holiday. Nearly $40 billion in April paydowns were out, and pool allocation on Class A securities was set for last Thursday.
Mortgages added to their performance gains in May, bringing the Lehman Brothers MBS Index to 11 basis points over Treasurys, up from seven basis points over as of May 4. At this point, mortgages are the best-performing cross sector for the month and are even ahead of corporates, which have increased seven basis points so far in May. Year-to-date, the MBS Index is lagging corporates at 14 basis points over versus 23 basis points over. However, mortgages remain ahead of ABS (at negative five basis points) and CMBS (at negative 32 basis points).
Investor participation was widespread and two-way over the course of the week. Some market strength on Tuesday led to profit taking from various real and fast money investors by a ratio of 3 to1. Some of this was reversed on Wednesday as the market traded lower. Flows were directed mostly up in coupon. Over the week, Asian investors were buyers in the overnight and morning sessions, making up for some of their absence in the previous week. Originator selling, meanwhile, remained active at between $1.5 billion and $2.0 billion per day, consisting primarily of 5.5% and 6.0% coupons.
As noted above, last week included pool notification on Class A securities. After some excitement previously in FNMA rolls, particularly 5%s and 6.5%s, almost all rolls collapsed to carry. In fact, the FNMA 5% roll was trading negatively as all prior shorts are gone. FHLMC Gold rolls were trading somewhat special. The weakening of rolls was contributing to poor performance on Thursday for mortgage-backeds, despite a steeper curve and lower volatility.
Street mortgage outlook
This week has a modestly active calendar. On Tuesday, there is the release of the CPI and Empire State Manufacturing Index; Wednesday has housing starts and industrial production/capacity utilization; the Philly Fed Survey is released on Thursday; Friday has the first of the month Michigan Sentiment reading. There are a number of Federal Reserve officials giving talks, with several speaking at a credit derivatives conference in Atlanta. This includes chairman Ben Bernanke, who is scheduled for Tuesday. The Federal Reserve Chairman will also talk about mixing banking and commerce on Thursday.
In mortgages, this Tuesday begins the 48-hour notification for Class B securities (15-year MBS) and, Thursday begins those for Class C securities (30-year GNMAs).
Analysts remain more neutral on the mortgage sector as the heavy supply remains a negative factor. In addition, dealer inventories have been increasing again. As of the close of April 25, net outright positions in MBS at primary dealers jumped $9.4 billion to $43.3 billion. For the previous eight weeks, inventories had held below $40 billion after ranging from over $40 billion to nearly $60 billion from late September 2006 through mid-February.
Barclays Capital analysts moved from overweight to neutral on the mortgage basis last week. Although the mortgage basis looks a bit cheap on their models, they identified several risks.
One is that the recent economic data reduces the odds of a Federal Reserve rate cut. In fact, Barclays analysts still expect the Federal Reserve will be hiking rates sometime this year. Banks are also probably going to be limited supporters of MBS. This is partly because of slow deposit growth. Furthermore, the weak housing market is slowing prepayment speeds, which will harm valuations with much of the MBS universe at a discount.
On the other hand, Bear Stearns analysts believe that MBS spreads look more likely to tighten than to widen over the next few months, "supply notwithstanding." They cite the recent attractive dollar roll financings, the end of FAS 159-related selling from banks, as well as prospects for improved demand from foreign investors as positives. Mortgage supply is the big negative, analysts said, but they anticipate, "the positives look more likely to win."
As expected, mortgage application activity increased for the week ending May 4. The Refinance Index gained nearly 5% to 2115, its highest level since the March 23 week, when it reached 2198. Meanwhile, the Purchase Index was at 438, up 2.6%, the highest it's been since Jan. 2 when it reached 440. A year ago at this time, the Refinance Index was at 1427, while the Purchase Index stood at 417.
Within the Mortgage Bankers Association's (MBA) report, it noted that the association's adjusted Conventional Index was up 3.2%; however, the Government Index jumped 8.6% from the previous week. The MBA said the large jump in the Government Index, which is primarily composed of Federal Housing Authority loans, puts it at its highest level in nearly two years.
As a percent of total applications, refinancing share was up slightly to 41.8% from 41.5% previously. ARM share was also little changed at 18% versus 17.9% in the week ending April 27.
Fixed mortgage rates steady
Freddie Mac reported 30-year fixed mortgage rates dipped one basis point to 6.15% for the week ending May 11, while 15-year fixed mortgage rates were unchanged at 5.87%.
"Low employment growth in April - the slowest pace since November 2004 - and downward revisions to both February and March job growth tempered market concerns about future increases in the rate of inflation. As a result, mortgage rates were little changed this week," the GSE's chief economist Frank Nothaft said.
Nothaft added that despite a slowdown in house price growth, borrowers still refinanced their loans and extracted about $70.5 billion in cash from their home equity in 1Q07. This decreased slightly from $77 billion in 4Q06. He noted that the Federal Reserve Board said that homeowners had close to $11 trillion in home equity at the end of last year, which is an increase of 30% in the past three years.
A year ago, 30- and 15-year fixed mortgage rates were at 6.58% and 6.17%, respectively, putting the Refinance Index at a 1427 level.
On the adjustable-rate side, one-year ARM rates rose six basis points to 5.48%, while five-year hybrid ARM rates were up two basis points to 5.89%. Last year at this time, one-year ARM rates were 14 basis points higher at 5.62%, and five-year hybrids were at 6.22%.
With mortgage rates holding steady, application activity is expected to remain near current levels.
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