After two weeks of active buying, selling picked up and flows turned two-way as the curve flattened and periodically inverted. With most investor types participating - including servicers - activity moved up and down the coupon stack depending on the curve action. Mortgages held within a narrow range, however, helped by the favorable technicals. Originator selling continues to average less than $1 billion per day.

The near-term outlook suggests that mortgages are likely to struggle on further rallies as the strength encourages profit taking. There is also the concern that bank selling will pick up if 5% coupons hit $98. Support from overseas is also seen as sidelined as investors wait for yields to move higher.

The Street remains mixed on the sector. In research from Lehman Brothers last week, analysts were holding with their underweight. They see weak demand from banks and the GSEs, saying they don't expect these groups to exceed a 4% range in their mortgage portfolios. With the mortgage market predicted to grow in the 6% to 7% area, they are uncertain as to who will pick up this additional slack. Corporate crossover buying has been suggested as a source. Lehman believes that while it will show up in the early part of the year, analysts believe it is unlikely to keep valuations tight.

In research from UBS, analysts said they continue to like the basis. Their current coupon mortgage model shows mortgages to be slightly cheap - helped by the decline in volatility.

Refi Index increases another 10%

Mortgage application activity was mixed for the week ending Jan. 13. The Refinance Index rose another 10% to 1645.2, while the Purchase Index fell 3% to 443.9. The Mortgage Bankers Association noted that the Refinance Index was down 20% from a year ago, though it is currently at its highest level since mid-November.

As a percentage of total application activity, refinancings rose to 44% from 42% in the previous report. ARM share was also higher at 30.6% versus 28.1%.

Freddie Mac's survey recorded a sixth straight week of mortgage rate declines for the week ending Jan. 20. The 30-year fixed rate averaged 6.10%, down five basis points from last week. This is the lowest rates have been since Oct. 20, when it also averaged 6.10%. Rates are also down 27 basis points from November's high of 6.37%.

In other lending programs, 15-year fixed mortgage rates declined four basis points to 5.67%; 5/1 hybrid ARMs slipped one basis point to 5.75%; while one-year ARM rates rose to 5.18% from 5.15%.

"Over the last six weeks, long-term mortgage rates have dropped nearly a quarter of a percent in the face of little or no inflationary pressures," said Frank Nothaft, Freddie Mac's chief economist. "Our outlook for the housing industry continues to be that mortgage rates will remain affordable for the rest of the year at least, keeping the industry alive and well into the foreseeable future."

With the decline in longer fixed rates, expectations are for this week's Refinance Index to increase towards 1700 or higher.

Prepayment outlook

Consensus currently anticipates speeds slowing 15% to 16% in January. In the period covering the January report, mortgage rates were fairly stable averaging 6.27% in December versus 6.33% in November. However, the Refinance Index was down 16% - averaging around 1371 in December compared to 1633 in the previous month. Also contributing to the expected slowing are seasonal factors. Looking further out, speeds at this time are expected to hold relatively flat in February and then increase sharply in March.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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