December has been a slow month for mortgage-backed securities, but lenders and investors expect demand to pick up in the new year thanks to a recent uptick in mortgage rates.
The 30-year fixed-rate, no-point refinance mortgage was around 7% last Wednesday, compared with a low of 6.5% in mid-October.
The rise is already discouraging refinancing, and that is good news for investors in mortgage-backed securities, who lose interest and principal income when homeowners prepay their loans.
"Investors are probably going to be increasing their allocations to the market," said David N. Sherr, managing director at Lehman Brothers.
"I think mortgages are going to be one of the star performers in the first quarter or first half of next year, if rates stay the same," said William J. Denton, vice president for secondary marketing at PNC Mortgage in Vernon Hills, Ill.
December is usually slow, because issuers typically avoid adding more securities and lending slackens as yearend approaches. "We've seen a decline in our production in the last 30 days," Mr. Denton said. Rising rates have discouraged borrowing, he said.
"What has kept the spreads from really getting clobbered here is both Fannie and Freddie have been very supportive of the mortgage market in the last two months," Mr. Denton said.
Spreads on a Fannie Mae or Freddie Mac 6% 30-year conforming mortgage have fallen 40 basis points in the last three months because of purchasing by the two government-sponsored enterprises for their own portfolios. But spreads have risen in recent weeks, said William F. Quinn, director with Smith Breeden Associates Inc. in Overland Park, Kan.
Investors have stayed on the sidelines, he said, in contrast to August and September, when panic selling of mortgage securities took hold.
"One of those things that has made mortgages a little less attractive has been implied volatility," Mr. Quinn said. But mortgages have outperformed Treasuries as the bond market has sold off and interest rates have gone up, he noted.
One sign that the market is reviving is a surge in issuance of collateralized mortgage obligations in the past month as Wall Street firms take advantage of lower prices of securities. CMOs are packages of securities that Wall Street firms sell to institutional investors.
"A lot of the deals have been up-sized," said Ken Boertzell, a portfolio manager for New York Life Asset Management in Parsippany, N.J. "There's been good demand for CMOs, and it has kind of overpowered the supply generated by mortgage bankers," Mr. Boertzell added.
After taking a big step back in September, October, and November, the mortgage securities market has almost "stabilized" and has opened up opportunities for more CMO deals, Mr. Sherr said.
