Following the March employment report - and continuing through most of Monday's trading session - mortgages were hit pretty hard on the rate backup with heavy originator selling, profit-taking and sidelined buyers. The widening, however, drew back investors beginning late Monday and continuing into Tuesday and Wednesday. Buyers were wide-ranging, and they included fast-money accounts, money managers, hedge funds, banks, dealers and servicers. Early-week flows were focused both up and down the coupon stack. However, by mid-week, flows were more down in coupon. Originator selling, meanwhile, averaged around $2 billion per day.

Refinancing activity falls, purchases rise

Mortgage application activity was mixed for the week ending April 2. According to the Mortgage Bankers Association (MBA), the Purchase Index rose 7.6% to 478 and is at the second highest level for the year. The index hit 502 in mid-January. The Refi Index, on the other hand, fell 15% to 4126. Both reports were in line with expectations.

Looking ahead to this week's report, Countrywide Securities expects a sharp drop-off as a result of the increase in mortgage rates. Analysts say early indicators suggest a drop of 20% to 25%. In addition, activity is expected to be slowed due to the Good Friday holiday. As a percentage of total activity, refinancings were 57.1% versus 62.8% in the last survey. ARM share rose to 28.8% from 27.5%.

March prepayments slightly faster than expected

While prepayments were anticipated to increase dramatically in March, they were faster than consensus expectations, particularly in the higher coupons. For example, 30-year 2003 Fannie Mae 5% coupons increased 74% to 11% CPR versus a consensus call of 9% CPR. Meanwhile, 2003 6s rose 29% to 39% CPR versus expectations of 37% CPR. In 6.5s, speeds increased 23% to 24% CPR versus predictions of around a 16% gain from February. Finally, in 7s, speeds were estimated to increase around 15% to 17% CPR; however, they rose 17% to 23% CPR.

In comments from Bear Stearns, analysts note that a combination of ample capacity in the mortgage pipeline along with the sharp drop in rates early in March (following the employment report) appears to have allowed some transactions that were expected to close in April to be accelerated into March. At this time, however, Bear Stearns does not expect to make significant revisions to April projections. Projections for later months will be revised lower as a result of the recent selloff. Bear Stearns calculates that this latest selloff has reduced the market's refi exposure to 37% from 70% in March. The average borrower refinancing incentive has dropped from a high of 80 basis points in mid-March to just 30 basis points today, Bear Stearns added.

At this time, Lehman Brothers projects prepayments on 30-year 2003 Fannie 5s to increase to 13% CPR from 11%; 5.5s to increase 25% to 30% CPR; and 6s to be up 11% to 42% CPR. Lehman predicts speeds to decline around 40% in May for 5.5% and 5% coupons, and around 15% to 20% for higher coupons. Speeds in June are looking to be flat to 10% slower.

According to JPMorgan Securities, fixed-rate paydowns totaled around $88 billion, a 30% increase from February. As a result, the amount of outstanding fixed-rate MBS declined by $20 billion. With expectations of further increases in speeds in April, JPMorgan estimates total paydowns will be $118 billion.

As with conventionals, speeds were faster than consensus was predicting for Ginnie Mae MBS in March. For example, 2003 5s prepaid at 14% CPR versus expectations of 11% CPR, and 5.5s prepaid at 30% CPR versus a prediction of 25% CPR. Higher coupons increased 15% to 20% CPR versus expectations of 10% to 15% CPR gains. Also noted: speeds prepaid in line to slightly faster than comparable Fannie Maes. Analysts were expecting conventional speeds to pull ahead as mortgage lenders focused on the faster-to-close conventional market.

In comments from Nomura Securities International head of MBS research Art Frank suggests the faster speeds were likely due to servicer buyouts. He also said that high-premium Ginnies no longer have call protection and that most Street models have not caught up with that situation.

Mortgages underperform

Mortgages returned negative four basis points versus Treasuries and minus 10 basis points versus swaps, according to a report from Lehman. The firm noted that this was the first month in six months that the MBS Index recorded negative excess returns versus the benchmarks. A review of the various components of return showed carry was the primary contributor at 12 basis points compared with Treasurys and 9 basis points versus swaps. Spread movement contributed negative16 and negative 22 basis points, respectively.

The MBS sector was the second-worst performing sector for the month. Investment-grade corporates were the worst with negative 10 basis points in excess return. IG CMBS was the best- performing with 16 basis points, followed by ABS with 11 basis points, and agencies, which were flat. Overall, the Aggregate Index returned a negative two basis points for the month.

Year-to-date, the MBS Index has outperformed Treasurys by 31 basis points, making it the second top-performing sector. ABS is first with 69 basis points in excess return. Meanwhile, CMBS is up 30 basis points; agencies follow with 27 basis points; and IG corporates are last at just two basis points. Lastly, the Aggregate Index has returned 18 basis points so far this year.

By coupon, 5.5s and 7s were the only two sectors within the 30-year conventional TBA universe to record positive returns versus Treasurys - 2 and 5 basis points, respectively. Meanwhile, 5% and 6% coupons tied for the worst at negative 11 basis points, while 6.5s were down four basis points. Within the 15-year conventional realm, 6s and 6.5s returned one and 24 basis points, respectively, and 4.5s, 5s and 5.5s returned negative 4, negative 6 and negative 8 basis points, respectively. Year-to-date, the top-performing coupon in both 30- and 15-year conventionals is 6.5s with 63 and 100 basis points, respectively, in excess return.

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