Subprime and credit worries continued to insinuate themselves last week into broader areas, such as commercial paper and money management firms. This kept the flight to quality intact, swap spreads moving wider and volatility higher - all not to the benefit of MBS. The gains the MBS Index had in the first two weeks of August have now evaporated, and month-to-date through Aug. 14, the index is down 17 basis points versus Treasurys. On a positive note, MBS are doing better than the ABS Index, which is down 22 basis points, and the CMBS Index, which is off 77 basis points so far in August.
Since Aug. 8, when the 10-year Treasury yield hit a high of 4.86%, yields have declined 10.1 basis points to 4.759%, the price has risen to 100-04 from 97-07, and the 2s10s curve has steepened to 38.3 basis points from 21.9 basis points. Over this same period, the 30-year FNMA 5.5% coupon is down 1/32, and 6% coupons are off 2/32s.
Keeping MBS activity limited was a new round of unsettling subprime and credit news that including that BNP Paribas suspended redemptions from its subprime funds and Sentinel Management Group sought to halt payouts and later in the week reporting it had frozen the assets of its clients. Also, Canada-based Coventree said it could not place ABCP because of the liquidity squeeze, and shares of Thornburg Mortgage Asset lost 47% of their value following downgrades by brokerage firms and Moody's Investors Service. And of course, Merrill Lynch downgraded Countrywide Financial to a sell from a buy, based on concerns that the lender could face bankruptcy if the liquidity pullout worsens (see story page 16).
MBS volume remained generally below normal in mixed flows. Breaks on the subprime headlines allowed for some real and fast money buying down in coupon. This tended to get reversed, however, as volatility ticked up and swap spreads widened as more subprime troubles and rumors emerged. Investors have been moving down in coupon in order to move away from the supply coupons. Asia remained light and mixed given the market uncertainty. Finally, originator selling averaged $1.5 billion to $2 billion, with supply primarily in 6%s and to a smaller extent in 6.5%s.
Mortgage Outlook
Mortgage analysts' tone was mostly neutral on the mortgage basis last week. Deutsche Bank Securities, for instance, upgraded its recommendation to neutral from a modest underweight of 30-year agency MBS based on the substantial spread widening between Treasurys and swaps over the summer, along with expectations that 30-year supply will be declining in the fall, unless mortgage rates rally enough to increase refinance incentives. Deutsche analysts are projecting September supply to total roughly $54 billion gross ($31 billion net) from estimates of $60 billion ($35 billion net) in August. They forecast supply to decline by November and December to $50 billion gross ($29 billion net).
An exception to the neutral tone, however, were the views of Countrywide Securities. Analysts at the firm said they believe a modest overweight in MBS has favorable risk/reward tradeoffs. "Valuations are currently cheap enough to allow for outperformance even if the sector does not substantially tighten," they said.
Mortgage Application Activity Rises
As expected, mortgage application activity picked up in the week ending Aug. 10 as mortgage rates declined to their lowest level since the first week of June. The Refinance Index gained 2.6%, to 1929.6 from 1881.1. This is the highest the index has been since mid-May, according to the Mortgage Bankers Association. A year ago, the Refinance Index was down to 1588, with mortgage rates near levels similar to current ones. The Purchase Index gained 3.9%, to 464.9. A year ago, purchase activity was at 386. As a percent of total applications, the refinancing share held steady at 39.9%. ARM share declined to 21% from 22.5% previously.
Prepayment Outlook
Speeds are expected to increase slightly in August as a result of a two-day increase in the number of collection days. In July, the 30-year fixed mortgage rate averaged 6.70% versus 6.66% in June. The Refinance Index averaged 1693 in July, down nearly 4% from June's average.
Speeds are currently expected to decline 15% to 20% in September as day count declines to 19 from 23, along with the traditional slowing in turnover with the start of fall. An increase in the number of collection days to 22 in October should contribute to an expected 10% to 15% increase in prepayments.
FHLMC Refi Product Transition Report
Freddie Mac released its quarterly Refinance Product Transition Report for the second quarter last week. The agency found that in the second quarter, 85% of borrowers who originally had a one-year adjustable-rate mortgage chose a new fixed-rate loan when they refinanced. This compares with 89% in this year's first quarter survey.
Specifically, 60% chose a 30-year fixed-rate mortgage, 17% took a 15-year fixed mortgage rate and 8% picked a 20-year. Of the 15% that stayed in adjustable product, only 4% chose to do another one-year ARM, while 10% chose a hybrid ARM product. In the first quarter, only 1% chose to stay in a one-year ARM and 8% chose a hybrid. In the second quarter, the widening spread between fixed and adjustable-rate mortgages made ARMs a bit more attractive than they were earlier in the year, said Freddie Mac Deputy Chief Economist Amy Crews Cutts.
For those borrowers who originally had a hybrid ARM, 86% went into a fixed-rate product, with 67% specifically choosing a 30-year fixed-rate mortgage. The other 14% stayed in hybrid. In the first quarter, 82% went into a fixed-rate mortgage, with 65% choosing a 30-year fixed mortgage rate and 18% taking out a new hybrid.
In the 30-year fixed-rate realm, 80% chose another 30-year fixed-rate mortgage when they refinanced, down just 1% from the first quarter. Ten percent chose a 20-year fixed rate, 6% a 15-year fixed rate and 4% a hybrid ARM. In the first quarter, 9% and 5%, respectively, chose a 20- and 15-year fixed rate, and 5% chose a hybrid.
This is the second quarterly survey in this new series from the GSE. The report tracks what types of loans borrowers are refinancing out of and going back into. Data for this report comes from a sample of properties on which Freddie Mac has funded at least two successive loans. Transactions are further screened to verify that the latest loan is for refinance rather than for home purchase, Freddie Mac said.
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