Mortgage volume was running substantially below normal through midweek with spreads steadily widening despite buying support from money managers, hedge funds, banks and the U.S. Department of the Treasury.
Factoring into the poor performance was CMBS widening as a result of the probability that two JPMorgan commercial loans originated last year were likely to default. This added to investor concerns over the financial crisis extending into another sector. Since the economic slowdown affects consumer spending, this is expected to, in turn, impact hotels, offices and shopping malls.
Poor volumes were also spurred by the focus on Capitol Hill hearings regarding TARP, its use for the auto industry and the uncertain outlook it engendered.
"The fundamental policy issue is our disappointment that funds are not being used out of the $700 billion to supplement mortgage foreclosure reduction," Chairman Barney Frank (D-Mass) stated at the TARP hearing.
Meanwhile, Republican member Spencer Bachus (R-Ala) said the changes without an adequate explanation "risks sending mixed signals to a marketplace that is in dire need of certainty and a sense of direction."
In his testimony, Treasury Secretary Henry Paulson defended the shift in TARP to not purchase distressed mortgage assets by saying that by the time legislation had passed, the global financial situation had deteriorated to such a degree that he believed the asset purchase program would not be effective enough.
"Therefore, we exercised the authority granted by Congress in this legislation to develop and quickly deploy a $250 billion capital injection program, fully anticipating we would follow that with a program for troubled asset purchases," Paulson said.
He added that with the worsening in global economic conditions, along with ongoing financial stresses, the $700 billion in troubled asset purchases would not be "enough firepower."
Paulson also suggested that without the authority that Congress had given Treasury through TARP and the progress that has been made, "our economic situation would be far worse today." As far as the housing and mortgage markets, he said in his testimony that in order to reduce the number of foreclosures, access to lower-cost mortgage lending must increase. He believes the actions already taken by Treasury regarding the GSEs as well as the bank capital program "are powerful actions to promote mortgage lending."
The automakers testified of dire consequences if the government did not extend them a loan. This further added to the uncertainty of the economic outlook going forward if any of the Big Three entered bankruptcy.
Deutsche Bank Economist Joseph LaVorgna said that if the Big Three automakers did file for bankruptcy protection, "the impact on the economy could be catastrophic." His initial thoughts were that this could lead to the unemployment rate spiking up to as high as 8% to 8.25% and 1Q09 GDP shrinking by at least 4%. "Suffice it to say, as bad as the economy is right now, it could get significantly worse," said LaVorgna, which pretty much sums up what likely was in investors' minds.
While there was demand for agency MBS, supply was limited to $1 billion per day. As Treasurys steadily strengthened, however, investor selling picked up from banks and money managers due to the higher prices. The 10-year Treasury was up nearly two points from the Friday, Nov. 14 close to midday on the following Wednesday, with the yield plunging 34 basis points to 3.41%. 2s10s were flatter by 26 basis points to 225 basis points. Current coupon FNMA 5.5%s had gained just 14 ticks over this same period.
MBS performance, which had been positive month-to-date through Monday versus Treasurys, turned negative on Tuesday. Barclays Capital's MBS Index was down four basis points month-to-date through Nov. 18 and was slightly lagging ABS (three basis points) and corporates (negative two basis points). CMBS underperformed by 1,961 basis points, having lost 825 basis points last Monday and Tuesday on the increased default fears.
Application Activity Mixed
Mortgage application activity was mixed in the week ending Nov. 14 with refinancing activity rising and purchase activity falling. The Mortgage Bankers Association's (MBA) Refinance Index rose 2.6% to 1281.2. Activity was expected to increase slightly in response to the decline in 30-year fixed mortgage rates to 6.14% from 6.2%, according to Freddie Mac's survey.
Meanwhile, the Purchase Index declined 12.6%, more than wiping out the previous week's increase, to 248.5. The level on the Purchase Index is the lowest since the end of 2000.
The MBA also reported lower mortgage rates with the 30-year mortgage contract rate falling eight basis points to 6.16%. One-year ARM rates were higher by three basis points to 6.80%.
Application activity is down substantially from a year ago, 42%, despite more attractive mortgage rates. Affecting activity is the weak housing market with further poor reports last week. Housing Starts for October fell 4.5% to a record low of 791,000, which was better than the 780,000 that economists were projecting. Building permits dropped 12% to 708,000, also a record low and substantially below the 780,000 that was predicted. By region, starts fell in the Northeast and Midwest and increased in the South and West.
The National Association of Home Builders' (NAHB) Index on builder sentiment dropped to a record low of 9 in November from 14 in October. Consensus was predicting the index to hold steady at 14. Two components of the index were lower: the index on current sales conditions, which fell 6 points to a record low of 8, and the index gauging traffic of prospective buyers, which fell to a record low of 7 from a revised 11 (previously reported as 12). Only the index on sales expectations in the next six months held at 19 - still a record low.
NAHB Chairman Sandy Dunn said the report "shows that we are in a crisis situation. If there's any hope of turning this economy around, Congress and the administration need to focus on stabilizing housing." Dunn also encouraged Congress to "consider significant consumer incentives" in order to stimulate homebuyer demand to help get housing and the economy moving again.
Street analysts retained their neutral stance on mortgages last week. JPMorgan analysts believe levered players are likely to remain near the sidelines as rolls are weak and ROEs are close to zero. However, they believe that strong buying from Treasury will help offset the selling from other investors, which kept them at neutral.
Barclays Capital analysts also held with a neutral outlook on the agency mortgage basis. Although Libor has improved and Treasury buying has been significant, they are concerned that Fannie Mae will have trouble growing its retained portfolio, that loan modifications could lead to higher prepayments (a negative for premium coupons), assuming that program is successful, and that lower mortgage rates could lead to increased supply in the short term.
While Treasury-sponsored buying is taking place, with October purchases totaling $21.5 billion and expected to hold at about this level, Credit Suisse analysts said that "aggressive and well-publicized buying" by the government is needed longer term to offset the imbalance caused by reduced support from overseas. Specifically, they anticipate less buying from China as it focuses its resources on stimulating economic growth.
November prepayments are predicted to decline about 20% on average from October with paydowns estimated at $34 billion. The slowing appears fairly uniform across coupons and vintages. Contributing to the slowing are four less collection days and a decline in refinancing activity. The MBA's Refinance Index averaged 24% lower in October versus September in response to a 16-basis-point increase on average to 6.2% on 30-year fixed mortgage rates.
December speeds are currently projected to increase between 10% and 15% as the number of collection days increases to 21 days from 18.
Not influencing speeds yet is the recently announced streamlined loan modification program. Barclays Capital analysts said they don't expect buyouts related to this to show up until 1Q09.
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