Although nobody in the mortgage market is denying the onset of a fairly significant refi boom comparable to the one in 1998 (see ASR 1/15/01), some participants are taking the bloated numbers of the latest MBAA Refi Index survey with a grain of salt.

With the Index increasing from 1572.1 to 2800.6 last week and refinancing activity representing 64.1% of total applications, market analysts and investors were a little bit taken aback; however, some observers were attributing the high numbers to other factors, such as overall consolidation of the mortgage banking industry and a phenomenon known as "WAC creep," whereby incremental increases in weighted average coupons cause equivalent prepayment-speed increases.

"The people reporting to the Mortgage Bankers Association of America represent a bigger chunk of the mortgage market than they have in the past," said Lisa Brown Premo, an MBS portfolio manager at First Union. For example, in 1990, the percent of the market held by the top 25 originators was just a little bit over 28%, while in 1999 it was more than 57%, Premo said. The percent of the market held by the top 10 originators was just 17.5% in 1990, while today 39% of the market share is held by the top 10.

Additionally, the decision of mortgage bankers to either retain servicing or get it off their books affects what coupons they sell into. For instance, if they retain more servicing on their books, then it will be more likely that they sell a lower coupon; however, if they retain less servicing then they will sell a higher coupon, which contributes to prepayment speeds increasing more than they normally would.

"So if 7.5% coupons normally had a 7.95 WAC or 8.05 WAC, they now would be at 8.25," Premo said. "Moreover, MBS is at lower prices now, so this pretty egregious refi atmosphere has been priced in."

Speeds Are Not That High

Rajan Dabholkar, a prepayment analyst at Credit Suisse First Boston, added that another factor contributing to the increase in the percentage of refis is that there are enough hybrid ARMs in the market that are refinancible. "Hybrid ARMs affect the dollar value of refinanced mortgages, which affects the Refi Index. Two-hundred fifty billion dollars in hybrid ARMs prepay at 40 constant prepayment rate (CPR) on average, adding refi dollars," he said.

According to Dabholkar, 7.5% coupons on fixed-rate bonds are expected to have speeds in the mid-20s CPR, and 8s in the mid-40s CPR. "These are not peak speeds in those coupons. At the end of 1998, 7.5s were in the mid-50s CPR and 8s were in the high 50s."

Moreover, like seasoned issues that have already been through a refi wave, the refi story is feeling a bit of burnout. The "sky is falling" mantra has been mitigated by a large umbrella of comments from the Street and mortgage bankers saying that refi activity may not be as brisk as some would suspect.

The MBAA Refi Index may beg to differ, though there is some evidence that at least some of the rise there is left over demand from December, and not recent activity. Freddie Mac's mortgage survey has the average 30-year rate back above 7% as well, taking some of the heat off of mortgages.

No Surprise

Still, some analysts did not think that the spike in the Refi Index was particularly overstated. "Based on the activity we see from originators, which is up significantly, the numbers we've seen are not all that surprising," said Joan Rogers, an MBS analyst at J.P. Morgan Chase (formerly Chase Securities). "There has been a historical precedent for a short spike in refis in mid-January, largely due to a holiday effect. Borrowers are more sophisticated, and the outlook for lower rates was well advertised. There are solid fundamental reasons for the numbers to be that high."

"Prepayment speeds might even be faster now than in 1998," added Amitabh Arora, a prepayment analyst at Lehman Brothers. "If you compare the new collateral now with the collateral from 1997, the collateral that is six to nine months old today will be faster. Production from 2000 has larger loan sizes and better credit characteristics. Secondly, the market is more efficient than a few years ago, making it easier to refi."

Arora added that while newer collateral might speed up, seasoned pools might actually have slower speeds than in 1998, mainly because seasoned collateral for 1998 ('92 to '94 production) did not have sustained exposure to low rates. Additionally, more high-LTVs, low FICO scores and a high proportion of low-documentation loans means that premium coupons could have some of the highest speeds ever recorded.

One last factor that will impact speeds is housing price appreciation: Bank of America estimates that housing price appreciation will increase prepayment rates by approximately 10% in 2001, incremental to the increase attributable to lower mortgage rates.

"Borrowers will generally refinance at smaller interest rate thresholds - entailing a smaller reduction in monthly payments -if appreciated equity equals or exceeds the upfront fees and costs," notes Michael Youngblood, managing director of real estate research at BofA, in a recent research report. "The value of a home needs to appreciate by only 0.63% currently to offset all of the upfront fees and costs of refinancing. Furthermore, borrowers will even refinance non-economically - incurring higher monthly payments - to access appreciated equity."

According to these analysts, therefore, whether or not the Refi Index paints an accurate picture is not the issue. "The real question now is, can refis sustain that level if rates settle above 7%?" asked Rogers.

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