With the 10-year Treasury going below the 4% threshold, market fears of an imminent refinancing wave have resurfaced. Although market participants vary as to what specific threshold would tip the market over, everyone is aware that another refi spike might just be around the corner.
FTN Financial Capital Markets said that it would take the 10-year Treasury staying in the 3.80% to 3.90% range for a week to trigger another refinancing event. "That would be enough time for originators to re-calibrate their rates and give the media effect time to operate," said Walter Schmidt, senior vice president at FTN.
Data presented in an FTN report shows interesting points about the refinancing exposure on the 30-year Agency fixed-rate MBS universe. Analysts pointed out that the gross weighted average coupon profile of this 30-year stack is "lumpy," which means that the gross WACs are not evenly distributed and that there is a large exposure to refinancing at certain targets or trigger points. One of those targets, analysts said, was hit last Wednesday when the 10-year Treasury hit the 3.90% level.
Specifically, the main trigger points occur between the 20 basis point gross WAC bucket of 5.80% to 6%, equivalent to $477 billion outstanding. FTN said that roughly 30% of the whole 30-year stack is part of this relatively narrow bucket, adding that the high end of this narrow bucket is already over 50 basis points of the refinance inventive. Furthermore, the entire 20 basis point bucket will have 50 basis points of incentive if the 10-year Treasury yield falls to 3.80%.
"This is why we have constantly talked about a 3.80% to 3.90% range on the 10-year as the threshold for a refi event," note FTN analysts. "Of course, a refi event will not occur without the ability for these levels to sustain themselves for several trading periods. However, we are no longer talking about where is the right level. It has arrived." The proximity of a refinance event was one of the factors that compelled FTN analysts to put on a short-term MBS underweight, applying specifically to index-matching investors.
Kevin Jackson, vice president at RBC Dain Rauscher, said that for the sub-4% 10-year Treasury yield to have an impact on refinancings, mortgage rates should fall in lock step. However, there is a stickiness' to the mortgage rates offered to consumers. Mortgage rates are also driven by other factors, such as supply and demand fundamentals, lender competition as well as the movement into ARMs, which has caused 30-year mortgage rates to fall comparatively less.
Instead, Jackson believes that a lot of the refinancing will come by way of cash out refis, borrowers trading up, as well as strong seasonals going into summer. More importantly, Jackson said that refinancings would be driven by homeowners with teaser ARMs and ARMs closer to the reset date, evaluating whether or not they should move into longer- term fixed rates or stay in a floating rate this time around.
"A large part of the fixed-rate conforming population only has a 20 to 25 basis point incentive to refinance into a new fixed-rate loan and that's not enough to get people excited," said Bill Berliner, a senior strategist at Countrywide Securities. He added that a bigger rate move is needed to cause another refinancing wave, which he defined as revisiting the March 2004 experience where the Mortgage Bankers Association Refinance Index peaked at the 5000 level.
Aside from 30-year mortgage rates not being as low compared to Treasury yields as they were earlier in the year, the Refinance Index has become increasingly insensitive to rate movements. "If you look at the Refi Index, it's much less responsive to relatively small changes in the level of mortgage rates, " Berliner added.
With the growth of innovative products, such as negative amortization loans, the rate level becomes less of a factor driving borrower behavior, as payment management and equity utilization are also important in creating a refinancing incentive. He added that despite the flatter yield curve, Countrywide is not yet seeing a significant pickup in either fixed-to-fixed or ARM-to-fixed refi applications.
Despite the Treasury yield compression, Bill Chepolis, a managing director in the fixed-income group at Deutsche Asset Management, said that much of their portfolio strategies remain unchanged as they view the rally as more of a technical aberration and not as a sign of real weakness in the economy.
Chepolis said that they still like to remain shorter duration versus the Index and find better value in higher coupons where prepayments are not a concern. Seasonality factors, and not interest rate moves, are expected to boost prepayments, although a 10 to 15 basis point move south from here - implying a 3.75% or 3.80% 10-year Treasury yield - could cause "some prepayments to pick up," said Chepolis.
He added that there hasn't really been a rate move to generate a massive amount of refinancings because borrowers have been moving out of 30-year fixed-rate mortgages into adjustable-rate type investments. At this point, people are more concerned about the shape of the curve, which would determine whether borrowers would move out of their ARM loan into a fixed-rate mortgage.
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