Last week the Mortgage Bankers Association (MBA) Refinancing Index rose sharply to 8920.9, the highest number ever recorded in the 13-year history of the index. As prepayments are set to break records in the upcoming months, analysts are telling investors to add prepayment-protected securities now as the universe of refinanceable mortgages grows by leaps and bounds.
With mortgage rates at an all-time-low - down 10 basis points week-over- week- last week's Refi Index broke the record set on Oct. 4, 2002. The just-below-9000 reading represents a 30% increase from the previous peak last October. It is also a 35% increase from the prior week's level of 6614, a jump that actually surprised some analysts.
"Although we expected the Index to break into record territory, we did not anticipate a more than 2000-point pop," wrote researchers from Salomon Smith Barney last Wednesday. "The magnitude of the increase (by far the biggest surprise this week) is probably related to a sharper rate of decline in mortgage rates over the past few weeks. The very sharp decline in rates led to a rapid expansion of the universe of refinanceable mortgages resulting in a huge increase in the number of mortgage applications."
They added that last week was the 10th week in a row that the MBA Refinancing Index surpassed 5000. This would inevitably cause prepayments in the coming months to be very high. Most of the applications filed last week will likely close by April while some of the closings will be pushed into May, explained the analysts. However, some high-balance, high-credit-score applications might still close in March.
Fast like a flash
Most analysts all agree on one thing: Prepayment speeds are going to get faster and faster going forward.
"Given the magnitude of the Index, it is likely that most coupons will prepay at higher speeds in the next few months," wrote Salomon researchers. Although the increase in speeds will probably be highly uneven. Cuspy 5.5s and 6s will likely exhibit the sharpest increases in speeds. Meanwhile, speeds in higher premiums will probably only rise modestly.
Kevin Jackson, senior analyst at RBC Dain Rauscher, echoed Salomon's statement that today's MBA numbers imply a surge in upcoming prepayments.
He stated that there are now $506 billion in 30-year conventional 6.5s outstanding and $459 billion in 30-year conventional 6s outstanding. These actually represent the cusp of the refinancing curve and most likely would have the largest rise in prepayments over the upcoming months. Having 30-year mortgage rates at 5.67%, 6.5s are 143 basis points in the money while 30-year 6s are 93 basis points in the money
Aside from these, Jackson also expects that there can be a jump in 30-year 5.5s. He explained that there is now $239.6 billion in 30-year conventional 5.5s outstanding with a gross weighted-average coupon (WAC) of roughly 6.1% and 43 basis points of refinancing incentive. This also holds true for 15-year product. At 5.01% mortgage rates, there might also be a surge in 15-year 5.5s and 6s prepayments.
Last major refinancing threshold
In a recent report, Bear Stearns noted the rise in both the MBA Refinancing Index and the Conventional Refinancing Index, which jumped by 34.9% to 10,053. The Conventional Index is about 2300 points higher than the prior peak reached in October (similar to the Refi Index that rose 2000 points higher).
"The increases are consistent with our longstanding view that the Refinancing Index would be relatively unresponsive to lower mortgage rates unless rates breached the 5.60% to 5.70% area on the 30-year rate," Bear Stearns analysts said.
With mortgage rates hitting below 5.70%, some of the pools backing the brand-new conventional 5.5% cohort start to enter the refinancing window. "The 5.60% to 5.70% mortgage rate zone is the last major refinancing threshold in the current MBS market," wrote researchers. They said that if the 30-year dips to 5.0%, a whopping 96% of all mortgage-backeds actually will be refinanceable.
As of last Thursday, Bear Stearns said that the 30-year mortgage rate was at 5.625%. At that level, they calculated that 89.4% of the mortgage market, which is equivalent to $2.51 trillion, is exposed to a refinancing incentive of 40 basis points or over. They noted that the average refinancing incentive that these borrowers have now is 140 basis points.
For this week's Refinancing Index, analysts expect that it will stay in the high 8000s (somewhere in the 8700 to 8800 range), though probably not exceeding the 8900 mark since rates went up sharply on Thursday. Rates were actually up 20 basis points from where they were at the beginning of the week. Mortgage rates earlier in the week were reflected by the 5.61% 30-year mortgage rate reported in the Freddie Mac Primary Mortgage Market Survey.
Though it is possible that there was a significant amount of applications filed in the beginning of last week (when rates were really low), pushing the results of the Refinancing Index upwards, analysts doubt that it would exceed 8900 significantly even in this event.
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