Heavy originator supply has yet to materialize within the mortgage sector, although a couple of trading sessions last week saw about $2 billion of selling, but the remainder of the week saw limited trading between $500 million and $750 million per day. At the same time, the MBS sector experienced steady buying from banks, money managers, arbitrage accounts, and dealers, helped by continued steepness in the yield curve.
In particular, last week saw better activity in 7s and premium coupons due to 48-hour settlement for 30-year conventional RMBS, and from the modest back up in yields. Overall, spreads closed the week two to three basis points wider versus Treasuries.
The lack of significant supply, given the substantial increases in the MBA Refi and AFS Title Search Indexes, is a bit perplexing. One Wall Street firm suggested that the lack of supply seen by the street seems to be a function of servicers bypassing dealers and purchasing mortgages directly from their bankers. Nonetheless, supply is expected to increase tremendously in the weeks ahead. Currently, the street is estimating between $125 billion and $150 billion per month by December.
The supply surge is based on the 90% increase in the Mortgage Bankers Association's Mortgage Refi Index over the past three weeks as mortgage rates continue to drop. As of last Wednesday, the Refi Index stood at 4286, just under its record of 4389 reached the week of on Oct. 5, 1998. On Thursday, Freddie Mac announced further declines in mortgage rates for the week ended Oct 12. The 30-year fixed mortgage rate fell six basis points to 6.58% and is closing in on the low of 6.49% hit in October 1998. Meanwhile, 15-year fixed mortgage rates fell five basis points to 6.06%, and the one-year ARM declined to 5.26% from 5.34%. Fees and points on both 30- and 15-year mortgages also declined slightly to 0.8% from 0.9%. This suggests further gains are ahead for both the MBA Refi and AFS Title Search Indexes. Next week's numbers, however, may see some leveling off, according to Salomon, due to the back up in rates over the past couple of days, as well as, from the Columbus Day Holiday. Beyond that, the MBA's Refi Index is expected to top the 6000 level.
Prepayments are also expected to jump in the upcoming reports. Oct. 5, the agencies released prepays for the month of September, which showed speeds for seasoned currents and cusps and vintage premiums actually slowed moderately, while unseasoned premiums increased less than expected. The impact was due to four fewer business days versus August, as well as diminished activity following the events of Sept. 11. Looking ahead to October, speeds are seen increasing substantially from September. For example, unseasoned Fannie Mae 6.5s are expected to increase from 5% CPR to about 12% to 13% CPR and unseasoned 7s from 14% CPR to 34% to 36% CPR. Other vintage 6.5s and 7s are forecast to record increases of 55% to 85%. Speeds should continue to increase in November and peak in December at this time. Peak speeds in 2001 origination 6.5s are expected to be in the high-20% CPR range; 7s in the low-50s; and 7.5s in the low 60s.
Supply and prepayments appear to be a growing concern for investors. According to JPMorgan's bi-weekly MBS Client Survey, the share of overweights recorded a significant decline to 17.4% from 30.2% and is at its lowest reading in over two years. At the same time, neutral positions increased to 47.8% from 34.0%, while the share of underweights was little changed. Their survey also indicated that investors have moderately underweight MBS now.
Street analysts are generally neutral to slightly overweight due to near term concerns regarding supply and prepayments. Only two firms, Credit Suisse First Boston and JPMorgan are recommending heavy overweights due to the belief that demand will more than match net supply.