For weeks now, there has been a lot of talk about supply as the MBA Refi Index surged; however, not much was being seen on the Street. In part, this was attributed to mortgage bankers bypassing the Street and purchasing directly from their bankers. This trend began to change this week with mortgage banker selling doubling to around $8 billion.
Supply, both literally and figuratively, began to weigh on the market following the announcement from the Mortgage Bankers Association on Wednesday that its Refi Index had hit a record 5253, eclipsing the previous high of 4389 reached in October 1998 during the financial crisis.
Spreads, which had tightened between two and four basis points through Tuesday, gave back those gains on Wednesday and Thursday as investors became more cautious and took profits. Still, the outlook is favorable for continued strong buying from banks, money managers, CMO dealers, and others. Investors are generally neutral to slightly underweight the sector and with heavy paydowns, the steep yield curve, and excellent liquidity and credit quality, the sector should readily absorb the supply, sources said. Supply-induced widening is expected to keep investors interested.
Indexes gain, mortgage rates hold little changed
As noted above, the MBA Refi Index hit a record 5253 this week. The percentage of refi applications to total applications also set a new record at 76.5%. Since the terrorist attack on September 11, the index has surged 164% as 30-year fixed mortgage rates have dropped 28 basis points during this same time.
On Thursday, Freddie Mac announced that 30-year fixed rate mortgage rates increased a slight three basis points to 6.61% for the week ending October 19. Over the previous week, interest rates had drifted higher, however, this past week has seen yields come back down. If yields hold, mortgage rates could turn lower again. The AFS Title Search Index is also at its highest level since October 1998. At 271.0, the index set a new year-to-date high and is up nearly 50% following the September attack.
Looking ahead, the Refi and AFS indices are predicted to trend higher in the weeks ahead as mortgage rates hold near three-year lows. Specifically, the MBA Refi Index is expected to peak at the 6000 level at this time.
Supply and
Prepayment Impact
Based on the current Refi Index and supply levels experienced earlier this year, the Street is forecasting supply at between $125 billion and $150 billion per month by early next year. This compares to a $93 billion peak earlier this year before interest rates began increasing in late spring/early summer. Credit Suisse First Boston suggests, however, that capacity constraints by mortgage bankers may cap monthly production, which will effectively spread supply out over several months.
The surge in prepayments is expected to begin to hit in the October report that will be released on Wednesday, November 7. At this time, speeds are predicted to peak in December and then hold relatively steady. Currently, Lehman expects peak speeds of 43% CPR and 56% CPR, respectively, on 2001 conventional 7s and 7.5s. In September, these two coupons prepaid at 15% CPR and 28% CPR.
Street recommendations
Last week the Street was little changed regarding recommendations towards the sector. Most analysts remain cautious at neutral to slightly overweight due to supply and prepayment uncertainty.
CSFB and JPMorgan remain modestly overweight as they expect demand to outstrip net supply. In addition, they like the wide spreads, quality and liquidity. Preference holds for the 15-year sector, particularly 6s. In 30s, preference is for the middle of the coupon stack with avoidance in lower coupons on supply and higher coupons on prepayments. The Street also likes structured product.
