Prepayment concerns heightened once again last week when the market saw two-year lows for mortgages. According to a Lehman Brother's report mortgage rates went below 6.9% for the first time in more than two years in Tuesday's market uptrade

On the same day, Fannie 6.5s closed at par 12 upon 3/8s which has not happened since January 1999.

With the rally continuing until press time Thursday with Fannie 6.5s closing at par 18 and the Fannie current coupon yield at 6.37, analysts were predicting a print of 2300 to 2400 in this week's MBA Refinancing Index.

Last week's Refinancing Index rose 15.7% to 2048. Lehman said that the four-week average of the Index for the last four weeks (ended Aug. 24th) increased by 30% compared to the four-week period that ended July 13.

Despite the numbers, there was still optimism in the market. Analysts said that there was still good demand from banks and the GSEs.

"When I look at mortgages versus other asset classes be it Treasuries, Agency debt and swap spreads, I still think the sector is attractive," said an MBS buysider.

The investor said that the market is seeing more crossover buyers with regard to investors going out of corporates into mortgages.

In the world of corporates investors are dealing with both credit risk and interest-rate risk, whereas in mortgages the credit risk is eliminated. If they can get some lockout via the structure, there is some pretty attractive paper out there, said the investor.

"The other thing you have going for you is the fact that homeowners have a lot more options open to them with regard to what they could refinance into," she added.

An example an option would be hybrid ARMS. At the beginning of the year, the yield differential between three-year Treasurys and 10-year Treasurys was only two basis points. As of last Wednesday, the differential was 116 basis points.

"With the steepening of the curve, ARMs do look more attractive," said the investor. "Homeowners may not have been looking at hybrids at the beginning of the year, but today I would make the argument that they are now looking at it."

As the market rallied last week, the 7% coupon was once again in the spotlight.

Merrill Lynch said that the "number of refinanceable mortgage increases very rapidly as the market rallies, due to the large pool of 7s. There are more 7s now than there were in January 2001, while there are fewer 7.5s and 8s."

Merrill said that the 7% coupon will more likely refinance into the 6% coupon than it would have into the 6.5% coupon. Analysts stated that during the first six months, the 7% coupon was a coupon of choice as it was somehow insulated from both prepayments and supply. They said that the 6.5% coupon would probably replace the 7% coupon in this environment; as 7s refi into 6s the 6% coupon is created.

Analysts from Credit Suisse First Boston said that if the mortgage rates go down to the 6.50% level, then that would ignite "the mother of all refi waves". At this level 80% of the mortgage market will become refinanceable.

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