Subprime was the topic du jour last week with several pieces of negative news causing more flights-to-quality into midweek. The headlines included the delisting by the New York Stock Exchange of New Century's stock and the initiation of a criminal probe into the firm; news that subprime lender Accredited Home Lenders Holding Co. needed to raise money after meeting margin calls and cutting jobs and, finally, ResCap's reporting a steep drop in operating earnings for 2006 versus 2005 due to its nonprime asset portfolio.
In the midst of all these, the Mortgage Banker Association's fourth-quarter delinquency survey reported that delinquency rates on subprime ARMs jumped 122 basis points to 14.44%. The MBA's report also showed that 4.95% of subprime mortgage loans outstanding were in foreclosure at the end of the fourth quarter, up from 3.86% at the end of the third quarter.
Mortgage flows were active and mixed last week. The early part of the week saw better selling of the basis and moving up in coupon with 6%s particularly favored by investors. As mortgages weakened on the selling and uptick in volatility, very strong buying from real money began emerging late Tuesday and Wednesday. Servicers and fast money investors were mixed throughout the week, taking advantage of strengthening or cheapening to sell or add. The 15-year MBS sector was also seeing support as it benefited from the steeper yield curve. Overseas investing was mixed, though overall remained a limited sponsor. Originator selling remained above average at $1.5 billion per day and higher.
MBS has struggled on the subprime volatility in the market in recent weeks. Month-to-date, Lehman Brothers' MBS Index is up three basis points. Year-to-date, mortgages are lagging Treasuries at negative eight basis points. Over the period Friday, March 9 through Wednesday, March 14, 30-year FNMA discounts gained about 9/32s, 6s were up four ticks and 6.5s just 1 tick. In 15s, price gains ranged from 9/32nds on FNMA 4.5s to +5/32s on 6s. At the same time, 10-year Treasury prices were up 17 ticks with the yield down 7 basis points to 4.521%.
Mortgage outlook
This week's highlight is the two-day Federal Open Market Committee meeting that begins on Tuesday afternoon. No change in rates is expected from the Federal Reserve, so the statement (out Wednesday at 2:15 p.m.) will be the focus as it has been, especially following last week's inflation data. The economic calendar, meanwhile, is pretty light with housing starts on Tuesday and initial claims and leading indicators on Thursday.
Typically, market activity tends to slow down as the participants wait for the statement. Outside of this, subprime has taken center stage for now in the markets, and mortgage performance and activity is likely to be predicated on that as a result and less on the data. As such, expect accounts to sell into strength and buy on pullbacks as they hold to more of a "trading" mentality.
Most analysts' tone last week was more neutral to positive on the sector. For example, Citigroup Global Market analysts said it was neutral over the short term as they believe the going could be "bumpy" with potentially more aftershocks from the flight to quality. UBS analysts held to their overweight; however, they acknowledge that investors should not expect any sustainable basis improvement until global stock markets regain their footing. One factor favorable for mortgages and mentioned by several firms is expectation of declining volatility. Bear Stearns analysts, on the other hand, held to their neutral-to-negative stance on the basis given the nominal spreads of MBS to swaps and Treasuries on the risk of continued volatility.
Both refi and purchase indices see increases
As expected, mortgage application activity increased slightly in the week ending March 9 in response to slightly lower mortgage rates. According to the Mortgage Bankers Association, the Refinance Index was up 3.5% to 2312.2. This is slightly higher than the level reached in early December, and the highest the index has been since the middle of September 2005. A year ago, the Refinance Index was at 1574 with 30-year mortgage rates in the mid-6.20s. The Purchase Index gained 2.2% to 414.3.
As a percent of total applications, refinancings were little changed from the previous week at 46.2% versus 46.1%. ARM share was up slightly to 21.9% compared to 21.4% in the previous week.
Mortgage rates hold steady
Mortgage rates held steady last week "as the latest economic news gave no reason for change," Freddie Mac Chief Economist Frank Nothaft said. According to the GSE's weekly survey, 30-year fixed mortgage rates were unchanged at 6.14%. Rates remained at their lowest level since mid-December, when they ranged from 6.11% to 6.13%, which should keep mortgage application activity firm. A year ago, 30-year rates averaged 10bps higher at 6.24%.
The 15-year fixed-mortgage rates were up two basis points to 5.88%. Levels were similar to last year at this time. On the adjustable side, five-year hybrid ARM rates were unchanged at 5.90%, while one-year ARM rates declined five basis points to 5.42%.
Prepayment outlook
Speeds are expected to jump 25% in March. The period includes three additional collection days versus February (22 compared with 19) and seasonals start to pick up as well. Also contributing to the increase is the higher refinancing activity due to the recent drop in rates.
In April, speeds are expected to hold flat as the result of a two-day decline in the day count. Finally, May is projected to be up about 15% on a higher day count and strengthening seasonals.
Strong market declines tend to raise questions such as: at what level would it take to cause refinance waves of the magnitude seen from 2003 to 2005? Citigroup analysts addressed this question in research last week by assuming the magnitude of a refinance wave as determined by the refinanceable share of the mortgage universe.
Under this assumption, it would take about a 25 basis point drop in primary mortgage rates to raise aggregate speeds to the 20% CPR area experienced in the first half of 2005. They estimated primary mortgage rates would have to rally 50 basis points to raise aggregate speeds to the 30% CPR area seen in the spring of 2004. Finally, analysts projected a roughly 100 basis point drop in primary mortgage rates is needed to raise aggregate speeds to roughly 60% CPR as in the summer of 2003.
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