Though it would take going below the old lows - the 6.89% mortgage rate reached in late March - to hit another refi wave, refinancing activity in the 7% coupon is ready to hit the trigger.
"Seven percent is an important target that is going to get the ball rolling again in terms of refinancing," said Dale Westhoff, senior managing director at Bear Stearns.
According to an earlier research report from Bear (7/18/2001), the dollar volume of mortgages that are currently exposed to refinancing incentive is actually more than it was at the start of this year. This takes into account that about $87 billion has been issued in the 30-year 7% coupon since the beginning of 2001.
Elsewhere, the 7% coupon is critical as well.
"With the current mortgage rate, we will see a pick up in 7s," said Amitabh Arora, vp at Lehman Brothers.
Last Wednesday, Arora said that 7s would likely rise by 7% or 8% CPR from where they were presently and 3% to 4% CPR relative to the peaks earlier this year.
For instance, 2000 production peaked at about 24% CPR sometime in April or May. If rates were to remain the same as they were currently, 2000 production will likely be in the high 20s CPR range in a couple of months.
He said that the same would apply for 6.5s. The market would also likely see a pick-up in this coupon relative to peak prepayment speeds it experienced earlier this year.
However, as far as 7.5s and 8s are concerned, mortgage rates would need to decline at least another 15 basis points for the market to see a pick up in speeds for these coupons.
Market in denial
Despite the 7% threat, the mortgage market seems to be in denial. It is the summer, after all, and many market participants are on vacation. Aside from this, the mortgage market has been seeing better days lately, giving enough reason for mortgage players to be complacent.
"I think the market right now is fairly complacent about the level of prepayment risk," Bear's Westhoff said.
"If you look over the last month, mortgage securities are generally tighter across the board on an OAS basis even though the level of prepayment risk now is higher," added Westhoff. "We are entering a very market directional period for mortgages and will start to see supply pressure and potential spread widening below the 7.0% mortgage rate threshold."
Westhoff noted that another factor distinguishing the current refinancing wave is the enhanced streamlined processing capabilities of large originators. This has shortened the lag between interest rate moves and reported refinancing prepayments to as little as three weeks. This is why Bear is currently revising its August and September numbers.
According to David Montano, head of mortgage research at Credit Suisse Frist Boston, most mortgage originators have backlog pipelines at this point.
He said that he expects relatively high prepayments to continue for the next few months, irrespective of rates.
Montano added that to get new coupons refinanceable, 6.5s and 7s have to be "in-the-money." To get the 7s "in-the-money," a mortgage rate below 7% is needed, while to get 6.5s "in-the-money", mortgage rates should be around 6.5%.
However, mortgage rates should be around 6.7% to really heat up refinancing activity and to match the higher levels that were seen earlier this year.
Meanwhile, a UBS Warburg report said that to trigger another refinancing wave, mortgage rates have to move below the old lows. The lows for the year were reached in March when mortgage rates were down to 6.89%. The report said that we are 10-15 basis points from starting a significant pick-up in refinancings.
UBS said that we may not be too far from the March lows given the steepening of the curve since then. Moreover, the report stated that "we would expect to see some mortgage servicers and portfolio managers looking to make-up' duration, beginning with levels close to where we are now."
However, if the old lows would be revisited, refi activity would be comparatively muted.
"There is basically some burnout," said Glenn Boyd, an associate director from the mortgage strategy group at UBS. "Those who were ready and quick to refinance already did back in March. The people who are left have slightly less propensity to prepay for the same level of rates."
UBS defines a refi wave as two successive prints on the MBAA Refi Index above 2500. According to UBS, the Index highs were 2802, reached the week ending March 23.
Some sources say that to be able to trigger another refinancing wave two things have to occur: low rates and a media event that would highlight the rates.
For instance, if mortgage rates hit a low after a Fed cut, this would likely result in a lot of applications because of the media attention
"There has to be a dovetailing of low rates at the time when there is a media trigger out there," said an MBS strategist. "And the most noticeable media trigger is when the Fed comes in."