Mortgage flows last week were relatively light reflecting the holiday-shortened session. Originator selling averaged less than $1 billion per day and was focused in 5s and 5.5s. For the most part, buyers were sidelined due to the rich levels and limited carry advantage. Over the week, spreads on 30-year Fannie Maes widened one and two basis points, respectively, for 5s and 5.5s. Meanwhile, 6s were five basis points weaker, while 6.5s were three basis points tighter. Spreads on dwarf 4.5s through 5.5s were four basis points wider over the week.

Mortgage applications rise as rates dip.

Mortgage application activity rose for the week ending Feb. 13, according to the Mortgage Bankers Association (MBA). The Purchase Index gained 3% to 414 while the Refi Index was 6% higher to 3209. The gains were not surprising given the latest decline in mortgage rates. As a percentage of total applications, refinancings were 56.6% versus 56.9% in the previous report. The ARM share, meanwhile, increased to 27.1% from 26.3%.

Mortgage rates slipped last week, according to Freddie Mac's latest Primary Mortgage Market Survey. The survey said that rates are at their lowest levels so far for 2004, and are at similar levels seen last July.

The 30-year fixed-rate mortgage rate averaged 5.58% for the week ending Feb. 20, down eight basis points; 15-year fixed-rate mortgage rates fell nine basis points to 4.87%; and one-year ARM rates reported in at 3.53% versus 3.57% in the previous week.

Looking ahead to this week's MBA report, Lehman Brothers expects the seasonally adjusted Refi Index to hold above 3000 in the coming weeks. On an unadjusted basis, JPMorgan Securities believes the Refinancing Index will fall 20% to about 2600 due to the Presidents' Day holiday.

Prepayment outlook

The latest decline in mortgage rates - down to levels seen last July - is likely to have limited impact on refinancing activity. According to Citigroup Global Markets, about 43% of the mortgage universe is currently refinanceable versus 70% to 80% then. In fact, in order for the Refi Index to hit last summer's record level, Citigroup says mortgage rates would have to fall around 70 basis points from current levels.

Regarding the prepayment outlook, current consensus suggests declines of 5% to 10% in April; however, the recent rate movement may lead to some upward adjustment in speeds, which implies the potential for prepayments to hold flat to slightly lower instead. The table on this page gives the current consensus outlook on speeds for 30-year Fannie Mae and Ginnie Mae mortgage-backeds.

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