A strong sell-off last Monday on inflation concerns sent the mortgage market reeling as the 10-year Treasury yield surged past 4.30% and closed in on 4.40%. The sell-off was fueled in part by mortgage participants lengthening their portfolio duration as rates rose. MBS originator selling picked up and averaged around $1.5 billion per day. Servicers, not surprisingly, were better sellers as well. Not inspiring confidence either were Fannie Mae's accounting and capital surplus issues (see related story on p.17). Traditionally, the GSEs have been seen as a backstop bid, but that is less likely given Fannie's need to meet a 30% capital surplus requirement by Sept. 30.

While spreads widened dramatically over the first half of the week, real money investors were not confident to step out with the February employment report looming on Friday, after press time. By mid-week there was some interest from fast money and dealers as the market's tone improved - boosted by a slowed servicer selling. If Friday's report comes in as expected or weaker, the sector is expected to see strong support as the range holds. If the report is stronger than expected, mortgages are expected to see better selling as a result of re-balancing, higher volatility and extension risk fears.

Over the seven-day period ending March 2, spreads were eight to nine basis points wider versus Treasurys for 30-year FNMA 4.5s through 6s, and three to four basis points weaker for 15-year 4s through 5.5s.

MBS lag in February

February was not a good month for mortgages, according to analysts from Lehman Brothers. The MBS Index returned negative 13 basis points in excess return versus Treasurys and negative 10 basis points versus swaps. It was the worst performing sector. Meanwhile, agencies returned 13 basis points, ABS five basis points, CMBS 12 basis points, corporates 30 basis points, and the Aggregate return four basis points.

Mortgage application activity mixed as rates increase

Mortgage application activity was mixed for the holiday-shortened week ending Feb. 25. The Mortgage Bankers Association reported last Wednesday that the Purchase Index rose 5% to 440, while the Refinance Index slipped 10% to 2281 on a seasonally adjusted basis. As a percentage of total application activity, refinancings fell to 44.8% from 49.3%. ARM share, meanwhile, held steady at 30.7%.

Mortgage rates rose, as expected, in Freddie Mac's latest survey. According to the GSE, both 30- and 15-year fixed mortgage rates increased 10 basis points to 5.79% and 5.33%, respectively. The 30-year fixed-rate mortgage is up 22 basis points from its recent low of 5.57% for the week ending Feb. 11. It is also at its highest level since the end of 2004, when the 30-year mortgage rate rose to 5.81%. On the adjustable side, 5/1 hybrid rates jumped 12 basis points to 5.17%, while the one-year ARM rate slipped two basis points to 4.14%.

Given the increase in rates, application activity is expected to decline further this week. JPMorgan Securities is currently predicting the Refi Index to fall to the low 2000s from 2281.

Benign February prepay report expected

The February prepayment reports were scheduled to be out the evening of Friday, March 4. As of press time, speeds were generally expected to be little changed from January's speeds for most coupons and vintages. Looking ahead to March, speeds on FNMA MBS are currently predicted to surge around 25% to 30% in response to the decline in mortgage rates to below 5.60% a few weeks ago, as well as, three more collection days versus February. GNMA speeds are anticipated to increase 15% to 20%.

FHLMC reports strong 2004 home price appreciation

Last week, Freddie Mac reported its quarterly Conventional Mortgage Home Price Index rose an annualized 10.7% from the fourth quarter 2003 through the fourth quarter 2004. This compares to 8.4% for the prior year period. For the fourth quarter, home prices grew 9 % on an annualized basis. This compares to an upwardly revised rate of 17.5% in the third quarter.

Looking ahead to 2005, Freddie Mac is forecasting annual home price appreciation at between 7% and 8% in 2005. Strong home sales and higher values should result in another record year for purchase money mortgage originations, Freddie said, adding that it is currently projecting $1.51 trillion versus $1.48 trillion in 2004. Total originations, however, are expected to dip due to lower refinance volumes.

The Office of Federal Housing Enterprise Oversight also released its quarterly report on US home price growth last Tuesday. The government agency reported that average home prices increased 11.17% from 4Q03 through 4Q04. Quarterly appreciation was 6.77% on an annualized basis.

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

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