Mortgages experienced steady two-way flows most of last week, with spreads over the week tighter, despite the neutral to negative bias on the sector and higher risks at current interest rate levels and increased volatility. There was an up-in-coupon preference due to carry; however, lower coupons also did well for investors seeking convexity. Originator selling has picked up and is averaging close to $1.5 billion per day, mostly in 30-year 5.5s.
At current levels and market conditions, support for mortgages is limited. Analysts expect mortgage spreads to hold if interest rates back up, and to widen in a rally. And while there is plenty of cash available for investment, there are better convexity opportunities in CMBS and ABS right now, said JPMorgan Securities. The market is waiting for a catalyst to provide direction and that will be the employment report due out Sept. 3.
Mortgage application activity responds to lower rates
The Mortgage Bankers Association (MBA) reported a jump in application activity for the week ending Aug. 13. The Refinancing Index gained 21% to 1983, in line with Countrywide Securities expectations. The Purchase Index increased nearly 6% to 467. As a percentage of total application activity, refinancings were 40.7% versus 37.2% in the previous report. ARM share fell to 33.6% from 34.2%.
Commenting on the report, Jay Brinkmann, MBA's vice president of research and economics, said, "The jump in refinance loans comes after a fairly steady drop in rates over the last month." He added that more importantly, rates are currently about half of a percentage point below where they were the same time last year, creating a refinance incentive for those who have taken out home loans since the middle of last summer.
Freddie Mac reported slight declines in mortgage rates for the week ending Aug. 20. The 30-year fixed rate mortgage rate slipped four basis points to 5.81%; the 15-year fixed rate fell five basis points to 5.19%; and the one-year ARM rate declined seven basis points to 4.01%.
Analysts expect mortgage application activity to remain strong following this latest rate decline. Lehman Brothers said it expects the Refi Index to reach the low-2000s in this week's report, while JPMorgan predicts the Refi Index will increase to the 2300 area.
The effect on prepayments should become visible starting in the September reports (released in October). Current expectations are for speeds on 30-year 5.5s and 6s to increase around 5% to 10% in August, 20% in September, and to hold flat in October.
Banks ease lending standards for C&I loans
According to the latest quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices released by the Federal Reserve Board, banks continued to ease their lending standards for commercial and industrial (C&I) loans over the past three months. On net, about 30% of domestic commercial banks lowered loan rates spreads over cost of funds for large, middle-market, and small firms. The reason given was increased competition from other banks and non-bank lenders. Also noted: the improvement in the economy and increased risk tolerance.
In terms of commercial real estate lending, 9% of domestic banks on net also said they had eased lending standards. This is a slightly lower net fraction than in April. The net percentage of domestic banks that reported an increase in demand for commercial real estate (CRE) loans rose to 25% from 20% in the previous survey.
Over one-third of domestic banks, on net, noted demand for C&I loans from large and middle-market borrowers picked up since the April survey. Furthermore, 45% of domestic respondents also report an increase in inquiries from potential borrowers over this same period, similar to the April report. Loan officers attribute the increased demand to rising financing needs for accounts receivable and inventories, and investment in plant and equipment.
Regarding household lending, the net proportion of domestic banks indicating a higher interest in making consumer installment loans fell to 9% compared with 17% in April. At the same time, demand for consumer loans was weaker at 12% on net versus 22% of institutions in April. In a question regarding ARM lending, over one-half of banks reported that hybrids accounted for at least 75% of all ARMs originated over the past three months. Another 17% said that hybrids accounted for between 30% and 75% of all originations during the period.
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