Mortgages struggled again last week despite significant cheapening in the last few weeks. In addition to the rate levels bringing servicer selling and extension risk into the equation, the sector is suffering under strong supply, full dealer inventories, special Treasury repos, and unattractive carry. Until the market stabilizes, it appears overseas support will be minimal.
Servicers remained steady sellers throughout last week with selling focused on the move up from 5s into 6s. Originator activity was mostly uneventful, although selling reportedly was strong Thursday as the 10-year Treasury lost 12/32 to yield 4.65%. Supply during the week was mostly in 5.5s. Hedge funds were also better sellers. There was some real money popping up from time to time to take advantage of the cheapening. Investors, however, are currently very sensitive to a further rate back up, and are proceeding cautiously.
MBS analysts' tone over the week was more neutral. In mid-week comments, analysts from JPMorgan Securities retained their neutral outlook until last Friday - when the October prepayment reports came out - on expectations of a favorable prepayment report showing lower coupon speeds remaining relatively strong. Meanwhile, Bear Stearns analysts remain neutral to negative. Despite the par coupon being at its widest level to swaps on an OAS basis since last November, analysts still expect further spread widening given the current risks, including limited demand, poor carry, and increasing fixed-rate supply.
UBS analysts held with their modest overweight as they believe mortgages are now considered cheap. Some other pluses include the potential for improving dollar rolls, Fannie Mae reaching its 30% capital surplus requirement, and expectations for overseas support as well as crossover buying from corporate investors. Specifically, 30-year discounts are very cheap to higher coupon counterparts, "and should benefit from corporate crossover buying," according to UBS researchers.
Worst performing
month for mortgages
October was the worst performing month of the year for MBS, according to Lehman Brothers analysts. Losses for the month were 32 basis points versus Treasurys and 26 basis points versus swaps. Higher coupons outperformed versus lower coupons and 15-year collateral offered higher returns than 30-year product with investors reacting defensively to the yield back up.
MBS was also the worst performing sector of the major indexes for the month. For example, the Agency Index reported a seven basis point loss versus Treasurys; ABS lost three basis points; investment grade CMBS and corporates recorded six and 22 basis point losses, respectively; and the U.S. Aggregate declined 17 basis points.
Year-to-date, MBS has a negative excess return of 45 basis points versus Treasurys. Only investment grade corporates have performed worse, losing 105 basis points.
30-year mortgage
rate jumps
Mortgage rates jumped in Freddie Mac's latest weekly mortgage rate survey. Last week, the 30-year fixed mortgage rate soared 16 basis points to 6.31%. Since mortgage rates hit a 5.53% low in early July, the 30-year rate is up 78 basis points. Current levels are also the highest since the week ending June 18, 2004, when they hit 6.32%. Based on an average 0.5 point, the no-point rate is around 6.44%.
In other loan programs, the 15-year fixed rate also increased 16 basis points to 5.85% from 5.69% last week; 5/1 hybrids printed at 5.76%, up 13 basis points; and the one-year ARM rate rose to 5.09% from 4.91%, an 18 basis point jump.
Freddie Mac Chief Economist Frank Nothaft stated that despite lowered economic expectations resulting from the hurricanes, news of strong economic growth gave financial markets a jolt, adding the impetus that caused mortgage rates to increase further last week. However, he noted that although mortgage rates have increased lately, they remain roughly 2% lower compared to other interest rates made by other lending institutions, including car loan rates.
Mortgage application activity is expected to have ticked lower last week as a result of the higher rate environment. The Mortgage Bankers Association Refinance Index is expected to fall to roughly 1800 from 1863 in this week's report.
Prepayment outlook
Last Friday, the housing agencies released the October prepayment reports. Prior to the release, speeds were expected to slow around 7% to 8% from September as October's day count is 20 days versus 21 days in September. The 30-year mortgage rate reported by Freddie Mac was down just slightly on average for September at 5.77% versus 5.82% in August, while the MBA Refinance Index was fairly stable averaging 2192 in September compared to 2264 in August. JPMorgan analysts estimate paydowns will total around $51 billion.
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