Mortgages surged midweek on an announcement from the Federal Reserve of a new program to help ease the liquidity crisis. Specifically, the Fed announced an expansion of its securities lending program - a new term securities lending facility (TSLF). Under the program, the Fed will lend to primary dealers up to $200 billion of Treasury securities secured for 28 days instead of overnight, as they were in the current program (see story p. 15).
Active buying emerged from hedge funds, insurance companies and money managers. This pushed spreads on 5s and 5.5s to more than a point tighter shortly after the news was released. The strong tightening, along with more rumors regarding Bear Stearns's liquidity situation, led to a brief bout of profit taking and moved spreads modestly off their tights. Spreads held tighter into Wednesday in moderate two-way flows and ranged from 21 ticks better to the curve in 5%s to 14 ticks tighter in 6%s at midday.
In other sectors, GNMA/FNMA swaps were weaker in the first half of the week. Dollar rolls caught a small bid on the Federal Reserve news. Trading was light in specified pools. There had been concerns of a pickup in selling in specified pools based on the increased need to raise cash due to the higher haircuts; however, the Fed's new plan reduces this risk. Fifteen-year products lagged 30-year collateral through Wednesday. This resulted from the combined factors of the Fed news, curve flattening and lower volatility.
Month to date through March 11, the Lehman Brothers MBS Index was underperforming Treasurys by 123 basis points. Still, this has improved from the negative 199 basis points the index had recorded in the first four days of March. Returns in other sectors are listed at negative 35 basis points for ABS, negative 124 basis points for U.S. credit and negative 372 basis points for CMBS.
The Fed's new facility should help address some of the liquidity problems that have been negatively impacting the mortgage market. However, the sector still suffers from unfavorable technicals and more attractive valuations elsewhere. For example, Lehman pointed out that banks and the GSEs are capital constrained.
An example would be Citigroup's recent announcement, which provides proof that banks will not be marginal buyers. Further, record supply is expected in the agency sector, which Lehman projects to reach $580 billion in 2008. Another negative factor is that alternative sectors such as Alt-A and CMBS super senior triple-As offer wider spreads and better value.
Mortgage Applications Slip
Mortgage applications slipped in the week ending March 7 as a result of a jump in mortgage rates in the latter part of the week. The Mortgage Bankers Association reported that the 30-year fixed contract rate surged 39 basis points to 6.37% and is at its highest level since last October. Meanwhile, one-year ARMs skyrocketed 89 basis points to 6.72%. That week was a volatile one in MBS, with adverse headlines relating to delinquencies and foreclosures, firms not meeting margin calls, increasing haircuts and news that Citigroup would shrink its mortgage portfolio. The 10-year Treasury ranged from a closing high yield of 3.693% to a low of 3.543% over the week.
As a result of the gain in rates, refinancing activity declined 4.7% to 2448.2, totally offsetting the previous week's modest 4.5% gain. The Purchase Index was up slightly to 368.8 from 363.1.
As a percent of total applications, refinancings fell to 50.6% from 52.4% previously. ARM share was also lower at 15.5%, down from 17.3%.
Before the February prepayment news, the Street's consensus was calling for speeds to increase about 13% in March. Following a larger-than-expected increase in February speeds, partly in response to a rush of closings before the March 1 fee increases from the GSEs, prepayments are now projected to change slightly on 4.5s through 6.5s. The largest percentage declines are generally expected in 2007 and 2006 5%s and 5.5%s.
Another factor contributing to the slowing is that the refinance threshold has moved higher as a result of the higher delivery fees, Lehman analysts said. Additionally, mortgage rates were higher in February than in January, averaging 5.92% rather than 5.76%. The 16-basis-point average increase, however, masks the nominal rise in mortgage rates over the period Jan. 25 through Feb. 22, when the 30-year mortgage rate hit a multiyear low of 5.48% and then steadily climbed to 6.24% - a 76-basis-point gain. Similarly, the MBA's Refinance Index averaged 12% lower in February than in January. However, from the low-to-high move in mortgage rates, the index plummeted 108% from 5104 to 2459.
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