The wait and focus on the Presidential election kept volume below normal on Monday and Tuesday of last week. The tone, however, was decidedly supportive on the significant improvement in Libor, which led to a strengthening in dollar rolls.
Over the two days, money managers were reportedly two-way and primarily focused in 5.5s and 6s, while Asian investors were better - albeit light - buyers. While hedge funds were better sellers on Monday, they turned into buyers on Tuesday.
Further support on Tuesday came from servicers. Both of the latter two groups were focused in 5s and 5.5s.
Specifically, with regards to Tuesday's flows, buyers outnumbered sellers by 4:1, according to a report from Deutsche Bank Securities. Mortgages continued to rally on Wednesday on higher volume and buoyed by the dollar roll strength. Servicers remained a notable presence, and down-in-coupon trades continued to outperform, with spreads closing tighter to the curve by 10 ticks on 5s and by 9 ticks on 5.5s.
In other mortgage-related activity through midweek, originator supply averaged below $1 billion per day and consisted of 5.5s through 6.5s, 15s lagged 30s, GNMA/FNMAs were flat to slightly firmer, and specified pools were seeing better buying interest from money managers, helped by the improvement in term financing.
November is off to a strong start in agency MBS. Barclays Capital analysts said that the MBS Index outperformed Treasurys by 78 basis points month-to-date through Nov. 4. This compares to 30 basis points for CMBS, three basis points for ABS and negative three basis points for corporates. The month of October, however, was dismal, though MBS was better comparatively to ABS, CMBS and corporates. For October, the MBS Index lagged Treasurys by 152 basis points, while ABS lost 665 basis points, CMBS 1,020 basis points and corporates lagged by 580 basis points.Ginnie Mae gross issuance edged out Fannie Mae issuance for October. According to data from eMBS, Ginnie Mae issuance totaled $27.798 billion compared with Fannie Mae's $27.731 billion. Meanwhile, Freddie Mac issuance was roughly half that at $14.4 billion. Ginnie Mae represented 40% of total gross issuance, which compares to just 9% of total issuance for 2007. In addition, gross issuance for the month was less than September for both Fannie Mae and Freddie Mac by $7.7 billion and $3.4 billion, respectively, while Ginnie issuance was $2.1 billion more.
Mortgage Application Activity Falls
Mortgage application activity dropped, as expected, in response to the jump in mortgage rates in the last week of October. The Mortgage Bankers Association reported that the Refinance Index plunged 27.8% to 1075.4 in the week ending Oct. 31.
This was similar to the activity in mid to late August when mortgage rates were in the 6.40% area. The Purchase Index dropped 13.9% to 260.9. Refinance and purchase activity were at their lowest levels since the end of 2000.
For the month of October, the Refinance Index averaged 1317, down 24% from September's average, while mortgage rates averaged 6.20% compared with 6.04% previously. This will contribute to a decline in prepayments in November. Currently, speeds are expected to be down 15% to 20% from October's estimates. Contributing as well to the slowing are four less collection days.
As a percent of total applications, refinancing share declined to 42.9% from 46.9%. ARM, however, increased to 2.5% from 1.9% previously.
Mortgage Outlook
Mortgage analysts' tone last week ranged from neutral to positive on MBS. Credit Suisse analysts, for example, believed that risk reduction, balance sheet constraints and high volatility likely will be the dominant themes into yearend. As a result they were neutral until there is evidence of significant buying from the Treasury and GSEs and/or bank buying emerges. If and when this happens, however, they do anticipate a sharp tightening of the basis.
Citigroup Global Markets analysts said they were hesitant about outright views on the mortgage basis, as the frequent government intervention is causing unusual spread volatility.
JPMorgan Securities had turned "tactically" neutral on the mortgage basis for technical reasons prior to last week; however, they were once again more constructive on mortgages versus Treasurys, as they expect the GSEs will use the money from their recent high debt issuance to buy MBS. They noted that historically there is nearly a one-to-one correlation between GSE net debt issuance and mortgage purchases.
In addition, they pointed out that improving mortgage spreads relative to agency debt is also a positive for better sponsorship.
Bank of America Securities analysts also upgraded their view to overweight on agency MBS as a result of the recent cheapening. They expected these yield levels should attract "meaningful" buying from banks. They also anticipate interest from Treasury and the GSEs.
Prepayment Outlook
Prepayments in October are expected to jump nearly 50% in conventionals in response to the drop in mortgage rates in September and the surge in refinancing activity following the government takeover of the GSEs. The largest percentage gains are expected in 6% and 6.5% coupons. Meanwhile, GNMA projections suggest speeds will increase more than 10% with the largest increases in 6s.
Mortgage rates averaged 44 basis points lower to 6.04% in September compared with August's average, while the Refinance Index was up 64% to 1725. The month also has one extra collection day.
A damper on prepayment speeds, however, is the ongoing tight credit standards, as well as the declining demand for residential mortgage loans.
This was evidenced in the latest quarterly Senior Loan Officers Opinion Survey from the Federal Reserve. Specifically, with regards to prime residential mortgages, 6.7% of large banks indicated they had tightened credit standards "considerably" on prime residential mortgage loans in the past three months compared with 3.6% in the July survey.
On the demand side, 6.7% of large bank respondents reported "substantially" weaker demand in prime residential loans compared with 0% previously, while 53.3% reported "moderately" weaker demand versus 51.9%. Results were even worse for nontraditional and subprime mortgage categories.
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