Mortgages continued to take its cue from market direction - outperforming when the market strengthened and underperforming on sell-offs. Throughout most of the week, there were good two-way flows with participation coming primarily from domestic real and fast money. A sharp sell-off in Tuesday's trading session did encourage some overseas buying on Wednesday, but current yield levels have been limiting their participation. Flows were directed both up and down the coupon stack as changes in the yield curve shape influenced direction.
Technicals remain supportive for the sector with originator selling averaging $1 billion per day or less. Supply lately has been focused in 5.5% and 6% coupons.
Market sentiment remains mostly neutral due to the favorable technicals. Other sources of support include stable spreads, carry and corporate cross-over buying. Concerns include the rich valuations and the potential for bank demand to drop.
This week is month end and brings potential for late week support from indexers. Quarter end balance sheet adjustments are also anticipated from banks, while Japanese investors are expected to be quiet due to year-end.
Refi Index holds steady
Application activity was down just slightly for the week ending March 17. According to the Mortgage Bankers Association, overall activity slipped just 1.6% to 565. The Refinance Index was essentially unchanged at 1575 versus 1584 previously, while the Purchase Index declined 2% to 394. As a percentage of total application activity, refinancings were 38.1% versus 37.7% previously. ARM share was little changed at 28.3% compared to 28.8%.
Fixed rates slightly lower
Mortgage rates were mixed in the latest primary mortgage market survey from Freddie Mac. According to the GSE's Chief Economist Frank Nothaft, recent inflation news is not really worrisome. "The most recent economic indicators released this week showed that inflation is, indeed, being held in check," he said last week, adding that this allowed long-term mortgage rates to drift a little lower for the second week in a row. On the other hand, indications from Federal Reserve Chairman Ben Bernanke's speech Monday night suggesting additional rate hikes sent shorter-term rates higher, Nothaft said.
Freddie Mac's chief economist also noted that existing home sales for February were unexpectedly high, although some might attribute this to unseasonably warm January weather when those contracts closed. But Nothaft still believes that, "the housing industry remains fundamentally fit as we move into the spring buying season."
For the week ending March 24, the 30-year fixed mortgage rate declined two basis points to 6.32%, while the 15-year fixed slipped one basis point to 5.97%. On the adjustable side, 5/1 hybrid ARM rates rose to 5.96% from 5.93% previously, and one-year ARM rates were up four basis points to 5.41%.
With fixed rates showing a slight decline, refinancing activity is expected to hold steady to increase slightly in this week's report.
Day count affects upcoming prepay speeds
Current consensus estimates show speeds on Fannie 5.5s and lower increasing around 30% or more in March, with higher coupons prepaying 20% to 25% faster. The large increase is due primarily to a higher day count - 23 versus 19 in February - and improving seasonals. April speeds are anticipated to decline around 10% as day count declines to 19 days, then picks back up in May as the number of collection days rises to 22.
In their weekly research report Mortgage Strategy, UBS analysts said they continue to expect prepayments to rise by approximately 20% to 25% in March, followed by a 10% to15% dip in April. Analysts said that the majority of month-to-month variation in speeds will come in discounts, as day count is the overriding factor in prepayment changes through April, noting again that there are 19 days in February, 23 in March, and 19 in April.
CMBS update
On the CMBS front, first quarter issuance in fixed rate CMBS is expected to total over $40 billion at month's end. This will be the second highest issuance quarter on record and follows on the heels of the highest quarter on record - 4Q05 - when $47 billion was issued.
Majority - 55% - of the first quarter's issuance so far has been concentrated in March.
However, despite the supply, spreads have steadily tightened since the start of the year. For example, five-year triple-A tranches averaged 21 basis points over swaps in January, and 16 basis points over swaps so far in March, while 10-year triple-A tranches averaged 28 and 25 basis points over swaps, respectively. Current averages are the tightest since March 2005 for five-year classes and since August 2005 for 10-year classes.
The remaining deals that are expected to price before the end of the month include: JPMC 06-LDP6 ($2.1 billion), LB-UBS 06-C2 ($2.5 billion), BALL 06-LAQ ($2.3 billion) and WB 06-C24 ($2.0 billion). Looking ahead, the April pipeline currently shows a minimum $6 billion.
JPMorgan Securities analysts said that although five fixed-rate conduit transactions totaling approximately $12 billion are expected to price by the end of the month, they expect spreads to remain firm across the capital structure. They are also looking for the credit curve to continue to flatten through the end of the month. With JPMorgan Treasury strategists forecasting higher interest rates and a bear steepening of the yield curve, the firm's CMBS analysts continue to suggest that investors who do not hedge should shorten their duration.
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