It wasn't the Federal Open Market Committee that shook up the markets last week, but the surprising announcement from the Treasury about the 30-year bond's potential return. Treasury prices fell and the curve steepened on the news. The curve response elicited a modest response in mortgage flows - particularly from hedge funds - with moves up in coupon in 30s and into 15s. Servicers were also said to be adding duration with FNMA 5.5s and Dwarf 4.5s. The curve steepening, however, has resulted in a modest extension in FNMA 5s as well as the overall MBS Index, said JPMorgan Securities. As a result, analysts warn of potential servicer selling when durations are recalculated.
As of press time, there was still the April non-farm payrolls report to get through last Friday and there is some expectation that it could be stronger than expected. In general, a back up in yields is considered favorable for mortgages and could help bring in the overseas buyers. At current levels, however, mortgages are anticipated to hold in a narrow range.
Looking to this week, Tuesday begins the 48-hour notification period for 30-year conventionals, and Friday for 15-year MBS. The FNMA 5 roll has weakened from a couple of weeks ago following the Fannie Mae Mega report for April, though it still remains strong. The roll's strengthening provided a boost to the entire sector, said JPMorgan researchers who warned that when the roll collapses, "the flip side is also likely to be true," noting that FNMA 5s were April's primary production coupon and so far this month, it continues to dominate supply. In 15s, the roll hasn't been much of an issue this year, but JPMorgan analysts believe that could change as 15-year supply is down substantially as a result of the flattening curve.
Mortgage application activity and rates hold steady
Not unexpectedly mortgage application activity was little changed from the previous report as refinance activity shows limited response to mortgage rate levels. For the week ending April 29, the Mortgage Bankers Association reported the Purchase Index was essentially unchanged at 483 versus 482. The Refinance Index rose less than a half of a percent to 2061 from 2053. As a percentage of total application activity, refinancings were little changed at 39.1% versus 39.3%. ARM share declined to 33.4% from 34.7%.
Mortgage rates were stable to slightly lower, according to Freddie Mac's latest primary mortgage market survey. Last week the 30-year fixed mortgage rate reported in at 5.75% versus 5.78%. Meanwhile, 30-year rates are at their lowest level since early March, but still a good ways above this year's 5.57% mid-February low.
"Long-term mortgage rates, which dropped again for the fifth consecutive week, remain low enough to keep refinancing activity a viable option for many," Freddie Mac Chief Economist Frank Nothaft said. "Not only can homeowners take some equity out of their home, many may also be able to lower their mortgage rate at the same time."
Freddie Mac also reported the 15-year fixed rate averaged 5.31%, down two basis points; 5/1 hybids slipped four basis points to 5.16%; and the one-year ARM rate "was 4.22% versus 4.21% previously.
With mortgage rates holding steady last week, expectations are for this week's Refinance Index to hold in the 2000 area.
April prepayments expected to decline modestly
The April prepayment reports were released last Thursday as ASR was going to press. Fannie Mae speeds came in significantly slower. Although the downward direction was expected, Art Frank, head of mortgage research at Nomura Securities International said speeds were slower by a CPR or two than he expected. For instance, FNMA 5.5s of 2003 were down to 19 CPR from 24 CPR last month, 2003 6s were down to 29.6 CPR from 35.1 CPR in March while 2002 6.5s were also slower at 31.6 CPR from 36.9 CPR last month.
Expectations were for 30-year 4.5 and 5 speeds to hold flat, to slightly higher in April versus March with higher coupons slowing around 8% to10%. Influencing the report is a 21-day collection period versus 22.5 days in March. The 30-year mortgage rates impacting the report averaged 5.93% in March, up from 5.63% in February. At the same time, the MBA's Refinance Index averaged approximately 1999 in March versus 2444 in February.
Looking ahead to May, speeds are anticipated to slow another 8% to 10% on 5.5s and higher, while the lower coupons are anticipated to decline about 5%. Speeds in June are projected to increase about 5%.
Currently, the mortgage market's refinance exposure has increased slightly as a result of the latest rally to 29% versus 25% in April, say Bear Stearns analysts. Given the current level of mortgage rates, analysts expect to see continued robust prepayments resulting from both cash-out refinancings and refinancings into affordability products over the near term. Bear Stearns analysts add that the continued strength in home prices is being fueled by the "marginal borrower's ability to access the housing market through new affordability products." So until rates move high enough to exert constraints on the market or demand from the marginal borrower is satiated or credit performance begins to erode, the sector should continue to see record setting prepayments on 30-year discounts and in non prime MBS.
ARMs, IOs in the second half of 2004
In a survey released last week, the MBA said adjustable-rate and interest-only products accounted for 63% of mortgage originations in the second half of 2004. The survey represented about half of the mortgages originated in 2004.
"Consumers shift to ARMs when long-term rates rise and when the spread between long- and short-term rates widens," said MBA's Chief Economist Douglas Duncan. "This happens at the end of every refinance boom, so it's not a surprise that ARM share has risen over the last year." However, he added, "this interest rate cycle is unusual in that the increase in ARMs has occurred with a much smaller increase in rates than in past cycles. One reason is that house-price appreciation leading up to this ARM cycle was much stronger than in previous ones, creating affordability constraints that led a number of buyers to seek lower payments in ARMs."
Some other findings of the MBA's survey were:
* ARM originations were split fairly evenly between traditional ARMs (53%) and hybrid ARMs (47%). Traditional ARMs are defined as loans where the initial interest rate is fixed for a period of less than three years; hybrids are defined as loans that have initial rates fixed for a period of three years or longer.
* For first-mortgage originations, the LTV averaged about 76%, and the FICO score averaged 683.
* The dollar volume of second-mortgage production rose 17% in the second half of the year from the first half of 2004.
* Piggyback loans accounted for 66% of all second mortgage loans originated in the second half of the year, and 60% of the total dollar volume.
Freddie Mac reports increase in 1Q05 cash-out refis
Freddie Mac reported last week that in 1Q05, 64% of Freddie-owned loans that were refinanced resulted in new mortgage loans that were at least 5% higher than the original loan. This compares to 56% in 4Q04, and is the highest since the last quarter of 2000 when it reached 74% said Freddie Mac.
The survey noted that in the first quarter, the median old-to-new interest rate ratio was 1.13, meaning that half of the borrowers had original interest rates that were 13% higher than the interest rate on their new loan. According to Amy Crews Cutts, Freddie's deputy chief economist, homebuyers who refinanced their mortgages lowered their rate an average of 67 basis points. On an average loan size of $150,000, that lower rate means a $66 a month lower payment for savings of more than $790 annually.
The quarterly survey also reported that properties that were refinanced in the 1Q05 experienced a median house-appreciation of 16%, since loan origination. This compares to 15% in the 4Q04. Also, the median age of the original loan was 2.4 months, two months older than in 4Q04.
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