Mortgages have not done well thus far in the holiday-shortened week.  Volume was below normal with better selling,  especially from servicers.  They were selling lower coupons to move up in coupon to shed duration as Treasurys continued to sell-off. The 10-year Treasury yield backed up above 4%, up 60 basis points from the Oct. 6 close when the 10-year was at 3.426% as global fears surged as overseas government began arranging bailouts and guaranteeing deposits.

Other investors were actively selling as well, including money managers and hedge funds in 5s through 6s, while overseas were selling in both 30- and 15-year current coupons to move into GNMAs. Banks, however, took advantage of the widening to add in 5.5s and 6s. Meanwhile, supply was light at less than $1 billion per day.

The Treasury reported in its monthly statement for September that it had bought $5 billion in Fannie Mae and Freddie Mac MBS, as it had indicated it would following the takeover of the GSEs. Deutsche Banks analysts believe the Treasury could step up it pace of MBS purchases to help prevent further MBS widening and higher borrowing costs for homebuyers.  As a result, they are modestly positive on the MBS-to-Treasury basis over the intermediate term.  Barclays Capital analysts also upgraded their view on the basis, moving to an overweight  as they expect the government actions should "assuage investor's concerns and improve sentiment on the financial sector."  Libor has also started to decline which should help MBS with improvement in dollar rolls.    

The government also announced another plan to help capitalize banks starting with nine of the largest which should help with lending and investment.  On Tuesday, the U.S. government said it would buy $250 billion in preferred stock in nine large banks including Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan, Merrill Lynch, Morgan Stanley, State Street, and Wells Fargo. This is similar to what other countries have done recently. Aside from this, the Federal Deposit Insurance Corp. announced it will guarantee for a fee certain types of new debt issued by banks and thrifts. The money to pay for this is coming from the $700 billion bailout package recently passed by Congress.

These government programs should improve MBS performance.  Lehman Brothers' MBS Index shows MBS lagging Treasurys by 147 basis points month-to-date through Oct. 14. The sector, however, looks pretty good compared with the CMBS Index, which is down 717 basis points and corporates which are off 352 basis points.  ABS are outperforming by 28 basis points.

Mortgage application activity rose in the week ending Oct. 10 in response to a decline in mortgage rates.  Freddie Mac, for instance, reported the 30-year fixed mortgage rate declined 16 basis points to 5.94%.  The Mortgage Bankers Association (MBA) reported yesterday that the Refinance Index jumped 12.5% to 1514.2, while the Purchase Index remained almost the same at 313.5 versus 314.5 in the previous report.

Mortgage Bankers Association Associate Vice President of Economic Forecasting Orawin Velz, noted that yields were lower at the start of the week, which allowing for increased application activity. However, rates were substantially higher by the end of the week.

The yield on the 10-year Treasury note -- the benchmark for 30-year fixed mortgage rates -- moved up about 40 basis points over the course of the week, Velz noted. This was reflected in the mortgage rate information collected by the MBA showing the average contract interest rate for 30-year fixed mortgages rising 48 basis points to 6.47%.

As a percent of total applications, refinancing share increased to 46.4% from 43.4%.  ARM share was also slightly higher at 2.6% compared with 2.3% in the last report.

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