Mortgages benefited last week from very light supply - less than $1 billion per day on average - steady investor buying and favorable comments from Fed Chairman Alan Greenspan. Investor support came from a variety of account types including money managers, hedge funds, insurance companies and, to a lesser extent, banks. The rich levels also inspired some profit taking early in the week to the tune of more than $1.5 billion. Other activity included a strong bid for 30-year 5s and 6s on roll-related activity. Last week was settlement for 30-year conventionals, and these coupons traded through fail.

The market surged on Wednesday when Greenspan began his semiannual testimony to the House Financial Services Committee. He said the Fed could be patient about raising interest rates. This confirmed that the range-bound environment, carry trade and continuing steep yield curve would continue for a while - all favorable for mortgages.

Over the week, spreads tightened four and three basis points, respectively, for 30-year Fannie Mae 5s and 5.5s, while 6s and 6.5s tightened 12 and 17 basis points. The higher coupons benefited from the favorable January prepayment report, where speeds slowed more than predicted. In 15-year MBS, spreads firmed five basis points for 4.5s and 5s, and were seven basis points better for 5.5s.

Mortgage applications and rates decline

Mortgage applications declined slightly for the week ending Feb. 6, according to the Mortgage Bankers Association (MBA). The Purchase Index fell 9% to 402 and the Refi Index was down nearly 5% to 3099. Activity was in line with expectations. As a percentage of total mortgage applications, refinancings were virtually unchanged at 56.9% versus 57.0%. ARM share slipped to 26.3% from 27.2%.

Freddie Mac reported a decline in mortgage rates for the week ending Feb. 13. The 30-year fixed-rate mortgage rate fell six basis points to 5.66%. This was slightly more than what analysts were expecting. The 15-year fixed-rate mortgage rate was down seven basis points to 4.96%, while the one-year ARM rate reported in at 3.57% versus 3.61% last week.

At current levels, Lehman Brothers anticipates the Refi Index to remain close to 3000 in coming weeks. They also say they wouldn't be surprised if it falls below 3000.

January prepayment speeds slow more than expected

Prepayments slowed substantially more than expectations for both Fannie Mae and Ginnie Mae MBS. Consensus was calling for about a 5% decline on aggregate for 30-year Fannies; however, speeds slowed 15% to 20% instead. JPMorgan Securities warned that the report might be a major downside surprise. In comments from Bear Stearns, analysts noted that the report represents the flattest refinancing curve observed since early 2001. Bear Stearns says the January prepayment report is good news for premium passthrough and IO holders. JPMorgan adds that burnout may be finally materializing on seasoned 6s through 7s (see related story, p. 16).

Consensus was calling for slowing in Ginnie Mae MBS to be around 6% to 8% on aggregate; however, slowing was more in the 15% area. There was one exception: 2003 5.5s. Speeds on the unseasoned 5.5% vintage increased 1% CPR versus expectations of slowing 2% CPR. While the slowing was more than expected, Ginnie Mae speeds slowed less than the 15% to 20% that Fannie Mae MBS experienced. Analysts at Citigroup Global Markets suggest some reasons for the relatively strong speeds in comparison with conventionals: lender solicitation of FHA/VA loans as conventional activity slows and the tendency for government loans to close at the end of the month rather than spilling over into the next month. Servicer buyouts also may have contributed to the stronger speeds.

According to JPMorgan, fixed agency paydowns totaled approximately $54 billion, nearly a 17% decline from December. They also said the amount of outstanding agency fixed- rate MBS shrunk by $3 billion.

Prepayment outlook

JPMorgan says that the MBA's Refi Index over the past few weeks is running 15% to 20% lower than their expectations. If this continues, speeds, especially on 30-year 6s and higher, are likely to be slower than predicted, said analysts. Lehman also says the longer-term trend on premium prepayments are downward as there are signs of burnout in the more seasoned cohorts.

An early look at the February prepayment report suggest speeds will increase 20% to more than 30% for 30-year Fannie Mae 5s through 6s. Higher coupons are expected to increase about 10%. Further gains are expected in March with moderate declines seen in April.

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