Rate Rise, Refi Drop Bode Well for Mortgage-Backed Securities

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By JOSHUA BROCKMAN 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. …