Ahead of Wednesday's statement from the Federal Open Market Committee, mortgage volume was substantially below normal as many participants held close to the sidelines. The overall tone of the sector, however, was supportive though generally tracking the curve and swaps. Asian investors were a steady presence with interest focused in 5s and 5.5s, while money managers and other real money were buying in 5s through 6s. Hedge funds, meanwhile, were two-way while servicers were generally quiet.
Mortgages also benefited from tighter swap spreads and lower volatility as well as limited supply. In the first half of the week, originator selling averaged between $1.5 billion and $1.75 billion per day in 5.5s and 6s.
Following the Federal Reserve's decision on Wednesday afternoon, mortgage volume picked up to above average with active buying in 5s through 6s from real and fast money. Indexers also showed up on month-end buying. Mortgages closed three to four ticks tighter versus the curve, also benefiting from the sharp drop in volatility following the statement, which was as expected, and tightening in swap spreads.
In other mortgage activity through Wednesday, dollar rolls were slightly better bid, 15s slightly outperformed 30s, and GNMA/FNMAs were flat to slightly weaker as supply remains a factor.
Mortgages experienced their first positive performance month this year. Month-to-date through April 29, Lehman Brothers' MBS Index had recorded 81 basis points in excess return versus Treasurys. However, it lagged behind other competing sectors: ABS, 96 basis points; CMBS, 327 basis points; and U.S. credit, 234 basis points. Year-to-date, however, the MBS Index is leading at seven basis points versus negative 491 basis points for ABS, negative 442 basis points for CMBS and negative 182 bps for U.S. credit.
Mortgage Outlook
Last week MBS analysts were positive to neutral on the mortgage sector. For example, Citigroup Global Markets recommended investors maintain a significant overweight in agency MBS. They noted that with risk appetite improving, MBS offer attractively wide spreads. Also, the GSEs are able to be more supportive in the sector now that they can grow their portfolios. In fact, their recent monthly volume summaries from March showed retained commitments totaling $43 billion for Freddie Mac and $31 billion for Fannie Mae.
JPMorgan Securities analysts turned positive on the mortgage/Treasury basis but remained neutral on the mortgage/swap and mortgage/agency basis. Their more bullish view on mortgages versus Treasurys is dependent on expectations of swap spreads narrowing. They anticipate that some forces will allow swap spreads to tighten, including a jump in the U.S. budget deficit in fiscal year 2008 versus fiscal year 2007 that will result in a surge in Treasury issuance, and a concerted effort by central banks to narrow Libor relative to Fed Funds. Analysts acknowledged that a risk to their view is the potential for duration selling, but the recent curve flattening has helped reduce this. JPMorgan estimated swap spreads could tighten by about 20 basis points, which they say overwhelms some of the concerns regarding relative value - namely supply.
Meanwhile, Barclays Capital analysts remained neutral on the basis. One reason is that they believe some of the shift in risk sentiment recently is not justified by the housing and earnings data. In addition, they pointed out that Libor-OAS basis is wider now versus February. Based on all this, they believe the price of risk will rise from current levels, which is generally not favorable for spread products. Another reason for the neutral sentiment is that credit problems are accelerating. They noted that the number of loans moving underwater has jumped. They estimate that by midyear over 25% of Alt-A and subprime loans could have negative equity. While this doesn't directly affect agency MBS, analysts said, it is still a negative for all spread products.
Balancing out these negatives, however, were the prospects of lower volatility following the FOMC and nonfarm payrolls, and that the GSEs are there now to be a backstop if agency MBS spreads move wider.
Mortgage Applications Lower
Mortgage application activity fell 11.1% overall in response to the recent sharp increase in mortgage rates that brought the 30-year fixed rate to 6.03% from 5.88%. The Mortgage Bankers Association (MBA) reported that the Refinance Index dropped 16.7% to 1905.2 for the week ending April 25. In the past two reports, the Index has plummeted 34%. The Index stands at its lowest level since the last week of December, when it slowed to 1621 as a result of the holidays. A year ago, the Refinance Index stood at 2016 with the 30-year fixed mortgage rate averaging 6.16%.
The slowing in activity is likely to start showing up in the May and probably more fully in the June prepayment reports. Current expectations had speeds slightly faster, but the slowing is expected to revise estimates lower.
The Purchase Index declined 4.8% to 340.1, which is the lowest it's been since February 2003. The report noted that the Conventional Purchase Index decreased 5.2%, while the Government Index (largely Federal Housing Authority) slipped 3.7%.
The MBA reported a slight improvement in mortgage rates with the 30-year fixed contract rate averaging 6.01% versus 6.04% previously. The one-year ARM rate fell seven basis points to 6.86%.
As a percent of total applications, refinancing share was 45.7%, down from 49.2%, and is at similar levels to last October. ARM share was also lower, dropping to 5.9% from 6.5%.
Prepayment Outlook
Prepayment speeds on FNMAs are currently projected to be about flat overall in April. With the exception of 5% coupons, which are projected to increase 5% on average due to the higher day count and seasonals, speeds on other coupons look to be flat to slower. GNMA speeds are forecast to be slightly higher overall with 5% coupons also showing the largest percentage increases.
In general, a two-day higher day count appears to be mostly offset by higher mortgage rates and lower refinancing activity. For example, in March the 30-year fixed mortgage rate averaged 5.97% compared to 5.92% in February, while the MBA's Refinance Index averaged 13% lower from the previous month at 2919.
Mortgage Indexes
FH 30Yr
Fixed
Wk Refi Purchase Mortgage
Ending Index Index Rate
04/25/08 1905 340 6.03%
04/18/08 2286 357 5.88%
04/11/08 2866 382 5.88%
04/04/08 2725 385 5.88%
03/28/08 2636 356 5.85%
03/21/08 4255 404 5.87%
03/14/08 2335 365 6.13%
03/07/08 2448 369 6.03%
02/29/08 2569 363 6.24%
02/22/08 2459 358 6.04%
02/15/08 3534 358 5.72%
02/08/08 4902 404 5.67%
02/01/08 5054 405 5.68%
A Year Ago20164276.16%
Source: MBA, FHLMC
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