Last week was relatively quiet overall as investors waited for Friday's employment report. Originator selling averaged less than $1 billion per day, which held spreads in a narrow range. Investor activity was mixed with better buying seen early in the week, and a pickup in selling in the later part. Over the five-day period, spreads were three basis points tighter in 30-year Fannie Mae 5s; one basis point better in 5.5s and 6s; and seven basis points firmer in 6.5s. In 15-years, spreads were in one to two basis points for 4.5s through 5.5s and flat in 6s.

Better bank buying

Of note lately has been the pickup in mortgage buying from banks. Bank participation has been a big question for the market for several months. Bear Stearns commented recently on the renewed interest from depository institutions; however, analysts cautioned that one week does not indicate a trend. They believe that February should be a telling month for bank demand as it is "far enough into the quarter to see whether trends in loan demand and deposit growth could push banks and thrifts back into MBS as a balm to earnings."

One clue could be C&I lending. In the Federal Reserve's January 2004 Senior Loan Officer Opinion Survey on Bank Lending Practices, 18% of domestic banks, on net, reported easing lending standards for C&I loans for large and middle-market firms in the last three months. In addition to the easier credit standards, the banks also said they had eased a number of terms on C&I loans. About 25% of domestic banks said they had narrowed the spread of loan rates over their cost of funds for the large to middle-market borrowers. This compares with 14% in the October survey. There were two reasons behind their decision to ease credit standards and terms on C&I loans: aggressive competition from other banks and non-banks and an improvement in the economic outlook.

The survey also reported that for the first time since early 2000 demand for C&I loans strengthened. Over 20% of domestic banks, on net, reported increased demand from small firms, and 11% reported stronger demand from large and middle-market firms. This compares with 4% and 12% in the October survey, respectively. Inquiry activity from potential borrowers is also up with 36% of domestic respondents reporting an increase in inquiries versus 18% in October. There has been an easing in lending standards for commercial real estate loans as well as an increase in the maximum size of the loans banks were willing to make, the survey also reported. In addition, demand for CRE loans increased over the period. On the household side, the survey said that nearly 40% of the responding domestic banks said that demand for residential mortgage loans had deteriorated from October's survey.

Responding to the survey results, Lehman Brothers said that while C&I lending appears to have increased modestly recently, data from the Fed shows that C&I loans held by banks fell in the fourth quarter. Lehman expects C&I lending to increase modestly this year.

Bear Stearns said this report "may signal bank optimism that C&I portfolios will be able to hit their growth and income targets this year, reducing the need to use securities instead." However, David Hilder, Bear's bank analyst, cautioned that the improved demand might take several months to show up due to the lag between a borrower's expression of interest and an actual drawdown on funds.

For its part, JPMorgan Securities comments that while the Fed Survey seemed to imply some increase in C&I loan demand, "it is not supported by the data or by our own anecdotal evidence." So for now, it appears to be a wait-and-see game concerning whether banks will continue to support mortgages or whether an improving stock market and stronger economy will reduce bank interest.

Mortgages outperform in January

Lehman reported that its MBS Index outperformed Treasurys by 17 basis points and swaps by 11 basis points in January. The sector outperformed Agencies, which had 15 basis points in excess return versus Treasurys; IG corporates, which returned 16 basis points; and the Aggregate, which returned 13 basis points. The top performing sectors for January were ABS and CMBS, which had 30 basis points and 23 basis points in excess return, respectively.

Within the mortgage sector, 30-year conventional 6s were the top-performing coupon with 35 basis points in excess return. Following on its heels were 6.5s with 28 basis points, 5.5s were next at 23 basis points, and 7s had 15 basis points. Meanwhile, 5% coupons lost two basis points. In 15s, 6s were also the best performing coupon, returning 34 basis points. Coming in second were 6.5s with 29 basis points, followed by 5.5s with 10 basis points and 5s with 6 basis points. Finally, 4.5% coupons lost one basis point for the month.

Refi Index holds steady

As expected, mortgage application activity for the week ending Jan. 30 was little changed from the previous report. The Mortgage Bankers Association (MBA) reported a 1.7% decline in the Purchase Index to 444 on a seasonally adjusted basis as well as a 1.5% slowing in the Refi Index to 3251. As a percentage of total application activity, refinancings were 57% versus 58.5% in the previous report. ARM share increased to 27.2% from 26.3%.

In comments from Citigroup Global Markets, analysts said they were surprised the Refi Index held steady given the increase in mortgage rates. They suggest some media attention may have helped prop up activity.

Mortgage rates rose slightly for the week ending Feb. 5, according to Freddie Mac's latest mortgage rate survey. The 30-year fixed rate mortgage rate rose four basis points to 5.72%. The 15-year fixed rate mortgage rate gained six basis points to 5.03%. Lastly, the one-year ARM rate increased just two basis points to 3.61%. The report was in line with analysts' expectations. With mortgage rates holding in a narrow range, both JPMorgan and Lehman anticipate the Refi Index will hold in the range of 3000 in coming weeks.

Freddie reports 4Q03 cash out refis

Freddie Mac reported last week that during the fourth quarter, 45% of FHLMC-owned loans that were refinanced resulted in new mortgages that were at least 5 percent higher than the original loans. This compares to 34% in the third quarter and 40% for the same quarter a year ago.

The median age of the refinanced loan in the fourth quarter of 2003 was 2.2 years versus 1.7 years in the third quarter, and 2.4 years in the final quarter of 2002. Freddie Mac also reported that the median ratio of old to new rate was 1.22, meaning the rate on the new loan averaged 22% lower than the rate on the old loan. The survey also reported a 12% median house-price appreciation on the refinanced properties. During the third quarter of 2003, the median appreciation was 5%, and it was 11% for the fourth quarter 2002.

For all of 2003, Freddie Mac said that the monthly savings from reduced interest costs to households that refinanced totaled more than $1.6 billion.

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