The Mortgage Banker's Association's seasonally-adjusted Refi Index more than doubled last week, spiking 106% to 1572.1, and mortgage market observers are predicting that the index is going to continue to peak up in the next few weeks.
In fact, the surge of refi activity has been so overwhelming that several large originators were reporting heavy refinancing activity and application processing, keeping their doors open over the weekend, leading some participants to suggest that major lenders may have to revamp their marketing departments for the short-term.
"We took a lot of applications last weekend," said one source at a lending institution. "The marketing team doesn't really need to solicit anymore, they can just handle inquiries. "
The other refi benchmarks took gargantuan strides last week as well: the conventional refi component gained 64% to 1295, and the government refi component jumped 77% to 1072. The average contract interest rate for 30-year fixed-rate mortgages was 6.89%, decreasing from the previous week's rate of 7.07%.
In light of this news, many MBS investors and researchers who were caught off-guard were dusting off their old 1998 prepayment estimates, hoping to draw comparisons between the last major refi wave and the current one, which is expected to rear its head in prepayment-speed numbers starting in March.
"We've been here before," said Kathy Malus, an MBS investor at Federated Investors who has been trying to cope with all of the latest developments. "We actually did well last week in MBS land; we held in pretty well. The marketplace has priced in a lot of the nastiness with respect to how speeds will be. We have become such an efficient market - I think mortgages will do a decent job at keeping up with Treasurys."
Many analysts are predicting that mortgage rates may not exceed 7% over the next six months, meaning that nearly $1 trillion in mortgages will be eligible to be refinanced. With mortgage rates hovering near the 7% mark, more than 80% of the 2000/1999 universe is exposed to refi risk according to Bear Stearns, and over 50% of the entire MBS universe. Lehman Brothers anticipates that at current mortgage-rate levels, unseasoned 7.5% and 8% coupons will reach constant prepayment rates (CPR) that are 10% faster than those seen on unseasoned 7.5s and 8s during the 1998 refi wave.
"In fact, we have a good chance of seeing the fastest speeds on the 8s and 8.5s ever recorded," added Michael Youngblood, managing director of real estate research at Banc of America Securities. "This may be a bigger refi wave than in 1998. If you compare what we've seen so far with a football game, we're still doing warm-up exercises."
'98 vs. '01:
A Comparison of Waves
While the comparison of refi waves is certainly not an exact science by any means, market analysts and observers had a variety of opinions last week on how similar the current refi wave is to the 1998 wave.
And there was significant disagreement: while most of the analysts cited technological advances in refi processing as a key element in determining which wave is "larger," some pointed out that the overall economic, mortgage-rate and housing backdrop that exists today should make for a less intense refi wave than in 1998.
"In terms of actual volumes, the current refi wave is not comparable to the 1998 wave yet," said Bill Berliner, senior strategist at Countrywide Capital Markets. "In 1998, rates were significantly lower and they stayed that way for a pretty long time. In fact, it was a new low in rates in '98, and it was the first time that rates got to that level. So from that point of view, we don't expect it to be as large a refi wave. But there will be a significant pick-up in prepayments, considering the advances in technology made over the last few years - being able to do refinances quicker and more efficiently."
In fact, the refi waves that took place both in 1993 and 1998 were accompanied by new lows in mortgage rates, which stimulated volume that will not be seen this time around, Berliner added. CPRs for 1993 were in the 60 to 70 area.
Additionally, while a similar percentage of mortgage applications for refis are surfacing compared to late 1998, the overall number of people has changed, making the current wave less intimidating: last week, 58.3% of applications consisted of refis for conventionals, while 62.4% of applications were for refis on Nov. 20, 1998. So the two waves are similar in some respects, but the composition of the mortgage market has changed drastically over the last three months, from a purchase-oriented market to a refi market, Berliner noted.
David Montano, director of MBS research at Credit Suisse First Boston, agreed, adding that the 1998 wave reflected pent-up demand that does not exist now. Besides the fact that there is currently a higher concentration of discount coupons in the market, we are also entering a declining or flat housing market, while in 1998 there was a rising market.
"I'd say that approximately 45% of the mbs universe is refinancible now," Montano said. "Back in 1998, bankers were less concerned about appraisal and credit, but there is more due diligence now, which leads to longer lags. Moreover, rates are not all that low. They were lower, even back in May of 1999."
Similar, or Even Bigger?
Not everybody agreed, however: analysts at Salomon Smith Barney and Banc of America believe that market conditions that currently exist give way for a refi wave similar to or even larger that what was seen in 1998.
According to BofA's Youngblood, the relative newness of refinancible loans compared to '98 and the ease with which conventional loans can be refinanced portends a refi wave that may have a broader scope than the '98 wave.
"No one expects 10-year Treasury yields or mortgage-loan rates to be significantly higher than where they are now," Youngblood said. "These days, conventional loans can be refinanced without any verification of employment, without deposits, and sometimes, even without new appraisals - what we call frictionless refinancing.' Also, back in '98, most of the loans had been originated more than a year prior, which is not the case now. So, over the next six months, we should see prepayment speeds for premium coupons equal to or greater than historical numbers."
Salomon agreed that there are indications that the refi wave could actually be more aggressive than that of three years ago. Both home values and loan sizes increased, making it easier to qualify for a loan as well as bringing in more incentive to do so. There is also the notion that online facilitation of loan applications and automated systems have cut down on the cost of doing a refi.
The contrarians, however, would suggest that 6.5% mortgage-rate levels are still fresh in the minds of consumers, who may opt to wait for those levels to reappear, limiting any near-term refi activity.
CSFB's Montano noted that not only were there "frictionless refinancings" back in 1998 as well, but consumers are more leveraged now than in 1998, meaning that loan-to-value ratios have risen. Moreover, equity-take-outs, which were a large component of refinancings in 2000 (accounting for an estimated 30-40% of issuance) should decrease this year, as the rate of home appreciation tilts lower. All of these should be mitigating factors on prepayments, Montano said.
