The first part of the week saw better selling - especially in 5.5% coupons- as the 10-year yield backed up towards 4.40%. Servicers, in particular, were actively selling 5s to move up in coupon or out of the sector. Originator selling held to its $1 billion per day average. Supply continues to be in 5s and 5.5s, although there was some selling in 6s.

The sector saw more balanced flows midweek as real and fast money entered the picture to take advantage of the recent weakening. While the backup would normally attract overseas buying, it was limited last week as China was on holiday.

Sentiment is currently more neutral to bearish. A continued back up towards 4.50% could lead to additional servicer selling and increased extension risk. Other ongoing concerns are rising fixed-rate supply, limited bank support due to slowing deposit growth and increased C&I lending, unattractive carry, and new accounting issues with Fannie Mae (see related story on p 20). For now, the sector is seen as reacting to the changes in the shape of the yield curve. Countrywide Securities analysts noted in a recent report that if the market continues selling off, premiums will soon have more extension risk versus discounts. Higher coupons can outperform lower coupons if the following happen: the market sells off due to yield curve steepening, volatility stays subdued, and selling remains orderly.

While not seen as offsetting the negatives, some bright spots are ongoing overseas interest and a better outlook for Freddie Mac support. UBS analysts add that institutional buyers have funds to invest and the servicer-induced weakening offers an attractive opportunity.

Refinance Index holds as mortgage rates rise

The Mortgage Bankers Association reported that mortgage application activity was down just slightly for the week ending Sept. 30. The Refinance Index - which was expected to decline towards 1900 - was actually unchanged at 2107. The prospect of even higher rates later this year is likely spurring the activity. Meanwhile, purchase activity declined just 2% to 474, also less than expected. As a percentage of total application activity, refinancings rose to 44.5% from 43.9%. ARM share was also higher at 29.8% versus 28.8%.

JPMorgan Securities analysts noted that the Refinance Index was unchanged despite the nine basis points increase in mortgage rates. Considering that ARM share of applications picked up while purchase activity dropped, an increase in ARM refinancing - particularly into MTA products - seems to be the most plausible explanation, analysts say. Researchers once again predict this week's numbers to drop near 1900.

More mortgage rate increases

Freddie Mac reported a fourth straight week of increases in mortgage rates. For the week ending Oct. 7, the 30-year fixed mortgage rate rose seven basis points to 5.98% with an average half point. The 30-year is at its highest level since March 31, when it averaged 6.04%. Meanwhile, 15-year fixed rates were up six basis points to 5.54%; 5/1 hybrid ARM rates reported at 5.48% versus 5.44% last week; and the one-year ARM rate jumped nine basis points to 4.77%.

Freddie's Chief Economist Frank Nothaft explained that mortgage rates rising over the last four weeks was a partial result of the extended high energy costs, although Nothaft acknowledged that further concrete data is needed to predict the national economy's direction, including where mortgages are headed. Nothaft thinks the economy will continue to grow, but perhaps at a slower pace and that "mortgage rates will most likely continue to rise with the expansion of the economy."

Based on current market levels, zero-point 30-year mortgage rates are around 6.11%, suggesting further slowing in the Refinance Index, possibly towards 1800 in this week's release. The last time the Refinance Index fell below 2000 was for the week ending April 15, when it printed at 1870. The lowest the index has been this year is 1721, recorded the first week in January.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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