With the Mortgage Bankers Association (MBA) Refinancing Index lingering in the 5000 vicinity, expect prepayment speeds to rise significantly going forward, analysts said.

Countrywide Securities said that this level of refinancing activity suggests unexpectedly fast speeds on 30-year 5.5s, which can be partially attributed to borrower movement into hybrid ARMs (see related story, p. 16). In an earlier publication, Countrywide stated that the Refi Index has in the past served as a reliable indicator of overall prepayment volume.

The firm looked at the total dollar amount of paydowns in the 30- and 15-year sectors versus the Refi Index, and noted that this method tracks prepayment volume quite accurately. Through the analysis, it was found that a 5000 level in the Refi Index would mean $90 billion in total Fannie Mae and Freddie Mac 30- and 15-year prepayments.

"When working through this exercise, we were struck by the fact that it is virtually impossible to achieve the target prepayment volume without seeing 12 to 15 WALA 5.5s prepay in the vicinity of 40% CPR," wrote analysts. In other words, there are currently too many 5.5s in the market and relatively small unpaid balances of high coupons left to have $90 billion in paydowns and not have fast speeds on 5.5s. This is rather fast considering that 5.5s are just roughly 50 to 60 basis points in the money and most models would generate speeds for that level of incentive closer to 30% CPR.

The difference is due to the hybrid ARM effect, analysts wrote. Borrowers who move to a 5/1 hybrid ARM would like to save closer to 150 basis points.

Current refi activity

Last week the MBA reported that the Refinancing Index remained flat from the week before, increasing less than 1% to 4988.7 for the week ending March 19, from 4983.7 the prior week. Meanwhile, weekly average primary mortgage rates rose by a few basis points week-over-week.

On Wednesday, Citigroup Global Markets reported that the spread between primary and secondary mortgage rates widened in the past week by about 5 basis points to 10 basis points. The rise in the spread might mean that with the recent pickup in refinancing activity, processing pipelines have been filled to a point where

lenders no longer want to lower their rates to coincide with secondary market rallies.

"We maintain our view that a refinancing wave similar in magnitude to that of 2003 is still 60 basis points to 70 basis points away (in terms of secondary market rates)," penned researchers at Citi. To put this in perspective, the spread between primary and secondary mortgage rates is now about 35 basis points while it was 60 basis points in June last year. Furthermore, the share of refinancible mortgages is currently almost only at 40% to 45%. In contrast, it was 80% in June 2003. Both these factors point to a normal, weak media-effect refinancing environment, said Citi.

Weekly average mortgage rates hardly shifted week-over-week. As of March 23, primary market no-point mortgage rates ranged between 5.25% and 5.75%. The average no-point survey rate is 25 basis points over June 2003 lows. Going forward, this probably means secondary mortgage rates need to rally by roughly 55 basis points to reach historical lows in primary mortgage rates, 30 basis points to reach a new low and 25 basis points for spreads to widen. With weekly average mortgage rates hardly moving in the week that passed, the share of the refinancible universe stayed about the same, at 41% to 42%.

In terms of prepayments, Citi expects March speeds (which will be reflected in the April prepay report) to rise. On the aggregate level, analysts expect speeds to be at 32% to 33% CPR. Citi attributed the growth to three main factors: an increase in refi activity in February, a seasonal increase in housing turnover and more business days in March compared with February.

Large increases across the board are predicted. However, speeds of cuspy coupons - 5s and 5.5s - are likely to see the strongest accelerations. The rally in rates that happened in early March is expected to have an impact on the April and May prepay reports, which reflect prepay activity in March and April, respectively. Analysts expect April aggregate speeds to increase to 37% to 38% CPR, which is almost like those experienced in August last year.

Meanwhile, the MBA stated that the seasonally adjusted Purchase Index stayed almost flat week-over-week at 448.9, decreasing just 0.8% from 452.4. The refinance share increased to 63.1% from 62.8% the week before. MBA also reported that the average loan size of a conventional refinancing loan remained at $227,400.


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