MBS flows were modest last week as many participants remained out on vacation. However, in early trading Thursday - following the terrorist bombings in London - mortgage spreads were wider on the flight-to-quality bid in Treasurys and the uptick in volatility. The cheapening, however, drew good buying in 5.5s and 6s. Expectations are that investors will take advantage of the cheapening as near term events, such as non-farm payrolls and paydowns, tend to be supportive of the sector. Still, the tragedy unfolding in London does add some uncertainty to investor participation.

During most of the week, activity was focused on moving up in coupon into 5s, 5.5s and 6s. Money managers, in particular, were strong buyers of 6% coupons last week. Meanwhile, the early part of the week saw short covering in 5s as a result of the latest MBS bank holdings report for large banks. The report showed a $54 billion increase in passthroughs. This follows the $64 billion decline in the June 15 report. This also suggests that outright sales of passthroughs were probably around $10 billion to $12 billion, reported Merrill Lynch analysts, rather than substantially more as suggested by the $64 billion drop.

"Bank holdings thus are currently about $10 billion lower than they were as of June 8 and about $12 billion lower than at the end of May," analysts wrote. Earlier, Merrill analysts suggested that the rest of the securities sold were most likely offset with unsettled trades such as Megas, rolls or purchases for future settlement. However, since bonds came back within one week, Merrill analysts said that this likely implies that the offsetting transactions came in the form of Megas that had not settled as of June 15.

At any rate, says JPMorgan Securities, the Street does not appear to be short the FNMA 5 roll at this point (see related story p.13). The roll is currently trading at 5.125%.

Originator selling averaged around $1.25 billion, down from around $1.5 billion in the previous week, but still above the $1 billion daily average. The majority of supply is in 5% coupons.

Refi activity jumps 10% with rate decline

Mortgage application activity was higher last week after holding steady in the previous week. The Mortgage Bankers Association reported that the Refinance Index popped up 10% to 2788 in response to the previous week's decline in mortgage rates to 5.53%. The Purchase Index gained 9% to 521, not too far from the record 529 high seen the week ending June 10. As a percentage of total application activity, refinancings held steady at 45.7% versus 45.4% in the previous survey. ARM share increased slightly to 30.7% from 30%.

30-year mortgage rate backs up to 5.62%

Mortgage rates moved higher as interest rates backed up last week. According to Freddie Mac's latest survey, the 30-year fixed mortgage rate rose to 5.62% from 5.53% the previous week. At 5.53%, mortgage rates were at their lowest level since the 5.52% reported for the week ending April 1, 2004. Freddie Mac also reported the 15-year fixed rate gained eight basis points to 5.20%; the 5/1 hybrid ARMs rate averaged 5.19%, a 13 basis point increase; and the one-year ARM rate was reported at 4.33%, versus 4.24%.

"Although mortgage rates ticked up this week, the 30-year mortgage rate - apart from a brief two-week stint in March - has stayed below 6% all year," said Frank Nothaft, Freddie Mac chief economist. "As a result, the housing industry is likely headed for another record-breaking year." He cited as proof the MBA's Purchase Index increasing to just shy of the all-time record set in May.

With the increase in rates, expectations are for the Refinance Index to move back to the mid-2000 area in this week's report.

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

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