While flows were seen as choppy, mortgages held up better than expected last week even given all the negatives. Flows were two-way, with active participation from asset managers and fast money taking advantage of dips and profit taking on strength. Originators, meanwhile, were average to slightly average sellers with supply mainly in 5.5s and 5s.

Analysts for the most part were neutral to negative given the potential for an uptick in volume due to several factors, including: the looming Federal Open Market Committee meeting; increased supply on declining paydowns; more ARM to fixed refinancings; limited demand from overseas given current yield levels; expectations of lower bank interest with the potential decline in deposits; increased C&I lending; curve flattening; and lackluster rolls.

On the positive side, the GSE outlook is improving - albeit slightly. Freddie Mac's 30% capital surplus should be removed in October. Regarding Fannie Mae, Bear Stearns anticipates that the pace of the GSE's portfolio contraction should slow in the coming months, partly on the belief that it has met its excess capital requirements (see related story p.21).

Mortgage application activity lower overall

Mortgage application activity was mixed for the week ending Sept. 2. The Mortgage Bankers Association reported that the Refinancing Index declined a seasonally adjusted 7% to 2199; unadjusted, refinancings dropped 16%. By contrast, the Purchase Index rose 3% to 513, which is just shy of the record high of 529 set the week ending June 10. The Street had expected a modest increase to the 2400 area in response to the lower interest rates. As a percentage of total application activity, refinancings were 42.9% versus 44.8% in the previous report. ARM share increased to 28.2% versus 26.5%.

Mortgage rates increase just one to three basis points

After declining for four weeks, mortgage rates moved slightly higher in response to the recent backup in rates. Last week, Freddie Mac reported the 30-year fixed mortgage rate averaged 5.74%, up three basis points from the previous week; 15-year fixed mortgage rates were 5.32% versus 5.30%; 5/1 hybrids rose to 5.26% from 5.24%; and one-year ARMs reported in at 4.46%, just one basis point higher.

As mortgage rates held fairly steady, there is some potential for refinancing activity to increase this week to the 2250 to 2300 area, Lehman Brothers analysts said, as the previous week's activity may have been distorted due to the Labor Day holiday. Countrywide Securities had also noted that they saw daily applications pick up following the break.

Sharp decline in September speeds expected

Preliminary indications are that prepayment speeds will slow about 15% to 20% in September. Seasonal factors are one contributor to the slower speeds; other factors influencing the decline include a lower day count, higher mortgage rates and a decline in refinancing activity. The day count in September totals 21 days versus 23 days in August. Mortgage rates averaged 5.82% in August versus 5.70% in July. The Refinancing Index, meanwhile, averaged about 2264 in August versus 2436 in July.

There have been questions about what impact Hurricane Katrina might have on mortgage prepayments. Analysts generally expect it to be minimal.

In research last week, Countrywide Securities analysts state that the overall MBS market exposure to losses is relatively minimal, largely due to the small dollar values of many of the properties in the area. This also suggests that there would relatively be more of an impact on GNMA Is, particularly those issued by smaller regional lenders.

Researchers also note that a prepayment will occur on an impacted property if the borrower chooses not to rebuild. In this event, the money is passed on as a prepayment.

If the homeowner does rebuild, the insurance money is placed into trust and dispersed over the construction project, and so this event does not lead to a prepayment.

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

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