The week saw better MBS buying overall as the market settled down following a sell-off related to the stronger-than-expected Chicago PMI and ISM Index that spurred the 10-year Treasury yield to 4.32% at last Monday's close from 4.19% on the previous Thursday. The backup resulted in heavy selling - particularly in the 5% coupon - from hedge funds and servicers shedding duration. The sector started to recover Tuesday as investors took advantage of the recent spread widening and set up for Friday's non-farm payrolls report. Trades of note included the up-in-coupon into 5.5s and 6s from servicers, and some short covering in 5s from money managers and hedge funds. Real money and overseas buyers also took advantage of the cheaper price levels. Originator selling, meanwhile, held to about $1 billion per day last week, down from around $1.5 billion in the previous week.

Analysts remain mixed on the sector. For example, JPMorgan Securities analysts believe mortgages are likely to provide flat to marginally negative excess returns at modest volatility levels. The near-term outlook is for even worse performance if the recent range is broken. UBS, on the other hand, is holding with its mortgage overweight. Analysts said cash-heavy investors taking advantage of the higher yields outweighed recent servicer selling, a pattern expected to continue. UBS prefers higher coupons, and while this trade has done well recently, UBS analysts believe it can go further. Countrywide Securities is also constructive on the sector, as long as the 10-year yield doesn't "break decisively above 4.35%." Breaking the threshold raises fears of extension risk and selling from servicers.

There are, however, near-term events that tend to be supportive of the sector. They include the July employment report, paydowns, settlement notification - 30-year conventionals on Tuesday - and the refunding supply in Treasurys. RBS Greenwich Capital analysts are cautious, however, noting that 30-year rolls are currently trading at carry and there is risk of further selling from servicers if yields back up moderately from current levels.

Application activity holds steady

The Mortgage Bankers Association reported last week that mortgage application activity held steady overall for the week ending July 29. The Purchase Index rose 2% to 495, reflecting continued strength in home buying. The Refinance Index slipped 3% to 2250. Activity was in-line with expectations. As a percentage of total application activity, refinancings were 41.7%, down from 42.9% previously. ARM share also declined to 28.5% from 29.4%.

Mortgage rates continued to creep higher with the increase in interest rates. Freddie Mac reported that the 30-year fixed mortgage rate averaged 5.82% for the week ending Aug. 5, from 5.77% the previous week. This is the highest rates have been since mid-April, but they are still lower than the year ago 5.99% level. Freddie Mac also reported a four basis point increase in 15-year fixed rates to 5.38%; a three basis point gain to 5.30% in 5/1 hybrids; and a print of 4.47% in the one-year ARM rate from 4.46% previously. For this week's mortgage application activity report, the Refinance Index is expected to decline to the low-to-mid 2100 area from 2250.

FHLMC reports 2Q05 cash-out refi activity

In its most recent cash-out activity report, Freddie Mac reported that in the second quarter, 74% of its loans were refinanced into new mortgages with loan amounts that were at least 5% higher than the original loan. This is up from 64% in the first quarter of this year, and is the highest since 4Q00 said Freddie (see story p15).

In the second quarter, 30-year fixed mortgage rates declined to their lowest level in a year, leading to increased refinancing activity. Meanwhile, the median ratio of old-to-new interest rate was 1.08, which means that one-half of borrowers who paid off their original loan had an original loan rate that was 8% higher than the new loan rate. Freddie economists noted that homeowners who refinanced their loans in the second quarter reduced their rate an average of 67 basis points, translating into a monthly savings of $64, or $760 annually for a $150,000 loan.

The survey also reported that properties refinanced during the quarter had a median price appreciation of 23% in the time since the original loan was made. This compares to 17% appreciation in the 1Q05 survey. Also, the original loan's median age was 2.6 years versus 2.4 years in the first quarter.

In terms of its outlook for housing, Freddie Mac is projecting home sales to set a new record in 2005 and expecting 30-year fixed mortgage rates to end the fourth quarter averaging 6%.

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

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