Volume was substantially lower in the first couple days of trading last week. One factor contributing to the scant numbers was the limited data throughout the week that concluded with a half day last Friday and was followed by the long Memorial Day weekend.
Flows were mixed. There was light buying from money managers and Asian investors, while banks and servicers were better sellers. The sense was that the buying from these investors has been in smaller amounts, which suggests that better interest would be available at lower prices. Originator selling averaged just over $1 billion in the first two days of trading.
Month-to-date through May 19, Lehman Brothers' MBS Index is outperforming Treasurys by 50 basis points. This is in line with U.S. credit but is lagging ABS (99 basis points) and CMBS (247 basis points). Year-to-date, however, mortgages maintain a significant advantage.
Mortgage Outlook
The Street analysts' tone last week ranged from neutral to positive on the mortgage basis. JPMorgan Securities analysts, for example, held their positive recommendation on the mortgage/ Treasury basis, as they expect swap spreads to narrow by 15 basis points in the two- and five-year parts of the curve and by 10 basis points in 10-years as a result of the heavy Treasury issuance and narrower Libor/Fed Funds.
Meanwhile, JPMorgan analysts remain neutral on mortgage/swaps and mortgage/agencies. They noted that MBS sponsorship has been rather strong lately from the banks and particularly from the agencies, based on GSE purchase commitments. Analysts estimated that banks bought $30 billion in the first quarter and, with the attractive financing through the Fed facilities, this could continue. Overseas investors have also exhibited a steady presence lately.
RBS Greenwich Capital analysts held to a short-term neutral view but recommended a modest overweight for investors with a horizon of at least three months. Near term, the analysts expressed uncertainty related to how the quarter will end and expect that the basis will be more volatile and the daily trading range will widen out.
Freddie Mac 1Q08 Transition Report
Freddie Mac released its quarterly transition report for the first quarter last week. The GSE said that 97% of prime conforming borrowers who originally had a one-year ARM refinanced into a conforming fixed rate (15-, 20- or 30-year), up from 92% in the fourth quarter.
Seventy percent of the respondents were into 30-year fixed. Meanwhile, 84% of conforming hybrid ARM borrowers who refinanced chose fixed-rate mortgages, compared with 89% in the previous quarter. Seventy-two percent chose
a 30-year loan, which remained unchanged from the fourth quarter. Meanwhile, 18% of one-year ARM and hybrid ARM borrowers refinanced back into an ARM loan, up from 16% in the fourth quarter.
Freddie Mac Chief Economist Frank Nothaft attributed the preference for fixed rates to "worry among borrowers about higher future interest rates."
Within the fixed-rate mortgage space, 79% of those that had a 30-year fixed refinanced back into a 30-year fixed, while 13% went to the shorter 15-year. In the last quarter, 83% went back into a 30-year, while 7% chose a 15-year mortgage.
Thirty-four percent of those that originally had a 15-year fixed mortgage preferred a 30-year fixed, while 60% stayed with a 15-year loan. In 4Q07, those refinancing from a 15-year into a 30-year made up 52% of the respondents, while only 38% chose to go back into a 15-year mortgage.
Prepayment Outlook
Prepayment speeds are currently expected to slow about 1% to 2% in May with the 2007 and 2006 vintages continuing to experience the largest percentage declines. Contributing factors include one less collection day in May versus April and lower refinancing activity on average. The Mortgage Banker Association's Refinance Index averaged 2411 in April compared to 2919 in March.
Looking ahead to June and July prepayments, speeds are expected to increase 1% to 2% on conventionals and slightly more for GNMAs, which will be bolstered by seasonals and steady-to-higher day count - 21 days in June and 22 days in July.
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