Flows opened last week relatively balanced with participation from a wide range of investors. The activity was boosted by supportive market events such as paydown reinvestments and Class A settlement.

However, things turned choppy on Tuesday with better selling by overseas investors, hedge funds and real money buyers in higher coupon 5.5s and 6s - both outright and versus the curve and swaps. Banks, on the other hand, were better buyers of 6s. Late in the session, equities sold off, sharply driving Treasury yields lower and causing servicers to scramble for duration. Money managers were also actively purchasing. Yields held lower overnight and into Wednesday's session, encouraging better selling based on strength, particularly in the lower part of the coupon stack.

By midday Wednesday, the 10-year Treasury yield was at 3.76%, compared with 3.84% as of the close on Tuesday. The 2s10s slope was at 113 basis points, which is its steepest level in over three years. Originator selling was relatively light in the first half of the week, averaging about $1 billion per day.

Month-to-date through Jan. 4, mortgages were off to a relatively good start. Lehman Brothers reported the MBS Index was down just a basis point versus Treasurys, while ABS were trailing by seven basis points and CMBS by nine basis points.

Mortgage Outlook

Street analysts were mostly neutral on mortgages. UBS analysts said last week that they were holding with their neutral weighting recommendation on the fixed-rate mortgage basis. They noted that, based on their model, mortgages currently look slightly rich. Additionally, the market remains jittery as a result of the ongoing negative headlines. A positive factor is that the market has seen increased demand from Asian investors, UBS analysts said.

Barclays Capital analysts also maintain a neutral view on mortgages. They said there are several positives in MBS, including a more accommodative Federal Reserve, the improvement in mortgage rates that should prevent discount speeds from slowing so much and the lessening of liquidity concerns partly due to the Fed's Term Auction Facility initiative. On the other hand, Barclays analysts said that MBS demand remains challenging from traditional sponsors such as banks and the GSEs. Market volatility also remains high.

JPMorgan Securities researchers expect banks to pick up selling, particularly in 5.5s, as available-for-sale portfolio losses have been reduced resulting from the rates declining.

Refi Activity Rises

The Mortgage Bankers Association reported a rebound in mortgage application activity in the week ending Jan. 4. In the previous three weeks, activity had dropped sharply primarily because of the holiday slowdown. There was also a decline in 30-year fixed mortgage rates to 6.07% from 6.17% in the previous week, according to Freddie Mac's weekly survey.

The Refinance Index surged 53.9% to 2494.2, recovering a substantial portion of its recent high of 2880 for the week ending Dec. 7, when mortgage rates had fallen to 5.96%. The Purchase Index rose 14.7% to 414.0. A year ago, the indices stood at 1924 and 473, respectively, with 30-year mortgages averaging 6.18%.

As a percentage of total applications, the refinancing share jumped to 57.7% from 50.9%. ARM share slipped to 9.3% from 9.8%.

The MBA also reported a substantial decline in the 30-year fixed contract rate to 5.73% from 6.05%. One-year ARM rates were slightly higher at 6.04% versus 6% previously.

2006 Vintage Prepays Jump

December prepayment reports that came out early last week were faster than expected. FNMA speeds were expected to increase about 2% overall in 4.5s through 6.5s. The gains were expected to come primarily from 2006 vintages, which were estimated to gain 7% on average, while other vintages were expected to increase about 1% on average.

Instead, speeds rose 6%, with 2006 vintages surging nearly 20% from November; other vintages rose 3% on average. The increase is attributed partly to improved mortgage rates that led to a pickup in November refinancing activity. For example, 30-year mortgage rates averaged 6.2% in November, down from 6.35% in October, according to Freddie Mac's weekly survey. At the same time, the MBA's Refinance Index averaged 2343 in November, up nearly 12% from the previous month. Lehman analysts also suggested that there was a "window dressing" impact with lenders pushing borrowers to close mortgages by yearend.

FHLMC Gold speeds were more in line with expectations overall. However, speeds on 2006 vintages were up 15% while other vintages declined 3% overall. Of note, speed percentage declines in the older 6% and 6.5% coupons were more than on corresponding FNMAs.

GNMA speeds were more in line overall with expectations. However, the 2006 vintages were substantially faster at 19% versus expectations of less than 7%. Other vintages were anticipated to increase nearly 1%, but they slowed nearly 4%.

Fixed-rate agency paydowns totaled $37 billion, according to JPMorgan analysts, up 13% from November. They said that net fixed-rate issuance (not including 10/20 IO) was about $54 billion.

January speeds are expected to be slightly lower overall. However, 2006 vintages are expected to again see percentage gains. Helping to buoy speeds are a slightly higher day count and lower mortgage rates.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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