This year's theme in the MBS market appears to be the potential slowing in the housing market and by extension, the resulting impact on prepayments. While there are some signs that housing may be slowing, a clearer idea of this isn't likely until the spring, when housing activity tends to pick up from the winter doldrums.
Elevated prepayments in the last two years have been due to strong home price appreciation, the increasing array and use of affordability mortgages, attractive mortgage rate levels and the steep yield curve. Although not to the level seen in the recent past, speeds on discounts are expected to remain relatively strong. Alec Crawford, managing director and head of agency MBS strategy, expects speeds will stay on the fast side despite a slowdown in home price growth. "There is still a fair amount of home price appreciation in the market," he said. "Tapping home equity is still a very strong trend among borrowers."
In a study by Merrill Lynch, analysts expect speeds on current coupons to be lower than in 2004 and 2005, however, they believe speeds will be higher than in the 1994 to 1997 period and at least as high as in 2000. They note in part that home prices aren't likely to fall overnight, and changes in borrower and lender attitudes take time.
Currently, estimates for home price appreciation for 2006 range from 3% to 8%.
Expectations are for a typical seasonal slowing over the next couple of months, before picking up again in March. Still, speeds in May are projected to be near December's levels, which were essentially the slowest in 2005.
Looking nearer to January's reports, previous estimates suggest around a 15% decline from December. In the period covering the January report, mortgage rates were fairly stable, averaging 6.27% in December versus 6.33% in November. The Refinance Index was down modestly in December, averaging around 1546 versus 1633 in the previous month. Also contributing to the expected slowing are seasonal factors. With the December data just out, firms will be revising their estimates over the next week or so.
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