Mortgages were slammed on Tuesday as investors returned from the long holiday weekend. It was said to be one of the worst days ever for MBS with substantial widening driven by active selling, wider swap spreads and higher volatility. Liquidity was severely lacking as well.
Treasurys sold off sharply on Tuesday with the 10-year Treasury closing down 24+/32nds with the yield rising 9.5 basis points to 3.875%. The 2s10s was 3.4 basis points flatter at 183.5 basis points. Treasurys were hit from a variety of sources. Initially, equities rallied on favorable Wal-Mart earnings news, higher energy shares on higher crude oil prices and gains to homebuilder stocks on the improved sentiment suggested by results from the National Association of Home Builders index. Stocks gave back their gains, however, as crude oil crossed the $100 per barrel mark. Treasurys were also hit by the higher oil prices, along with convexity-related selling and growing concerns about inflation.
MBS selling came from a variety of investors, including servicers, money managers, banks, insurance companies and leveraged investors. Flows were up-in-coupon. Originators were also heavy on Tuesday with supply at $2.5 billion, primarily in 5.5% coupons. Asian investors were light buyers, while some other real money purchases took advantage of the wider spreads. The 15-year collaterals outperformed their 30-year counterparts while specified pools saw good interest from CMO desks, banks and money managers. GNMAs also benefited from a flight to quality.
Wednesday's session opened with a sharp selloff following the stronger-than-expected inflation news. However, Treasurys started to recover mid-morning based, among other things, on ongoing credit concerns and equity weakness. The bad news included the fact that KKR would delay repayment on some mortgage debt again and that Citigroup cut its first-quarter estimates on Goldman Sachs, Lehman Brothers and Morgan Stanley because of mortgage-related losses. As Treasurys recovered, so did the tone in MBS for the remainder of the session. Strong buying emerged, including from overseas investors, who brought spreads tighter in 5s and 5.5s, and flat to just slightly weaker in 6s and 6.5s by midday.
Month-to-date through Feb. 20, the Lehman Brothers' MBS Index had underperformed Treasurys by 130 basis points. The ABS and U.S. credit indexes were better at negative 79 basis points and negative 40 basis points, respectively, while CMBS was worst at negative 492 basis points.
The near-term outlook is not encouraging. There are concerns about duration extension related to the weak housing market and tighter credit conditions, as well as supply. In addition, technicals are discouraging given the heavy supply because of limited interest from banks and the GSEs, which were caused by capital constraints. Last week, Lehman analysts recommended a core underweight to the basis versus swaps. They think that valuations need to widen further to get investors to switch out of other asset classes.
Barclays Capital analysts remain neutral on the basis despite the recent cheapening. They are concerned that there would be further financial disruptions based on more unwinds of leverage, including in non-MBS-securitized markets. They are also worried about additional bank write-downs as well as potentially negative earnings news from the GSEs.
Application Activity Plunges
Mortgage application activity plummeted in the week ending Feb. 15. The Mortgage Bankers Association reported that the Refinance Index dropped 27.9% to 3533.8, while the Purchase Index declined 11.5% to 357.6. This was much more than expected given that Freddie Mac's weekly survey reported just a five-basis-point increase in mortgage rates to 5.72% in that week. However, Freddie Mac's survey is done earlier in the week and so it did not capture the jump in rates in the latter part of the week. For example, the 10-year Treasury started the week off closing at 3.618% on Feb. 11 and ended the week at 3.78%.
As a percent of total application activity, refinancing share was 61.7%, down from 67.4% in the previous week. ARM share was higher at 12.8% from 9.9%.
February's prepayment speeds are expected to surge because of a sharp drop in mortgage rates and a jump in refinancing activity. For example, in January, the 30-year fixed mortgage rate averaged 5.76% compared with 6.10% in December, while the Refinance Index averaged 80% higher at 3838. A lower day count in February - 19 versus 21 days - partly offsets this.
Current initial projections suggest FNMA speeds will jump about 50% overall in February from January 2007. The 2006 vintages are seen surging over 60%, while older vintages are seen gaining around 40%. GNMA speeds are seen increasing much less on average at around 30% overall.
March speeds are currently estimated to increase 13% for both FNMAs and GNMAs, while April gains are predicted to be more moderate at less than 10%.
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