The MBA Refinance Index finally showed some action last week, reflecting a 42% jump in applications (borrowers reacted to a 6.55% mortgage rate from the week previous) - a move that was expected by most mortgage players. However, despite the significant rise in refis, it is still not as steep as that which was seen late last year when mortgage rates were at similar levels. The Index's rather moderate response to the level of rates has been an ongoing trend that many analysts have speculated on.

There are several reasons being given as to why borrowers' response to the current low rates is rather tepid.

Analysts said that current coupon composition of the mortgage market is different now than it was a year ago. In a sense, mortgage-backeds are currently in a post-refi wave scenario. During last year's refi wave, borrowers had mortgages with higher coupons that were usually in the 7.5% coupon and the 8.0% coupon. These same borrowers have already refinanced and now have loans in the 6.50% coupon. Experts say that the average WAC of the market is lower, so the sheer number of people who are refinanceable is now much less than the amount of people who were refinanceable a year ago, though rates are currently comparable to the lows seen late last year.

Furthermore, there is a psychological element. Borrowers saw the lowest rates in history last year, so it may seem to them that the rates that they have seen in 2002 are nothing in comparison to those. Because of this, borrowers are waiting for something a little bit more spectacular in the historical sense. However, as the market approaches the lows in November analysts say that it makes sense that people are starting to notice.

In a report released last Tuesday, Countrywide Securities cited additional factors "that are limiting the refinancing responsiveness of the mortgage market in the face of the significant drop in market rates." In an earlier report, analysts identified two factors that included the lack of a media effect (primarily the absence of Fed rate cuts) as well as the changing composition of the in-the-money coupons.

They noted that this lack of responsiveness could be attributed to the fact that consumer mortgage rates have not gone down that much, considering the considerable dip in Treasury and swap yields.

"This stickiness' is due in part to the under-performance of the passthrough market in the face of the last three weeks, as current-coupon spread has widened roughly 15 basis points," the analysts said.

They added that the spread between consumer mortgage rates and the current coupon rate has started to widen. The widening is a reflection of the low level of competitiveness between mortgage originators because of the prevailing lack of slack in supply.

In a report released when rates were still at a 6.64% level, Lehman Brothers answered the question as to whether going back to the December lows in rates would trigger the same response. Analysts said that there are two factors that would hinder another huge wave of refinancings similar to that seen in December 2001.

They stated that because of burnout, "the same cohorts will prepay at lower rates than they did in December." Aside from this, they noted that with the high paydowns that occurred in the last six months, the share of premiums in the index has declined.

One factor that could increase the level of refis, however, is the current attractiveness of the ARM alternative, analysts said. Last week's MBA report showed the highest ARM share of applications since the week ending June 16, 2000 - jumping to 18.6% from the prior week's level of 18.0%.

Investor reaction

Despite the comparatively subdued reaction to low rates, Steve Point, a fixed-income portfolio manager at Glenmede Trust Co., said that it would not be prudent to be complacent about this issue.

"The obvious fact is that refis are going to be picking up here," he said last Wednesday. He added that even just a week previous people were somewhat sanguine about the potential exposure in refinancing when and then the Refi Index suddenly surged. However, Point noted that there is some investor reluctance to capitulate on mortgages as a spread product, because the alternative spread product would be corporates, which does not appear all that attractive at this point.

"I don't see a mass exodus from the mortgage sector because there is still the question of Where do you go?,'" he noted. "There is a big gap in good market intelligence about where corporate bonds should trade."

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.