MBS Investors Look for Signs Homeowner Refinancings Have Peaked

(Bloomberg) -- Mortgage-bond investors are looking for signs that the wave of American homeowners refinancing their loans may have crested.

Agency mortgage-backed securities prepayment rates “have reached ‘terminal velocity' -- the maximum prepayment rate attainable given both servicer capacity and underwriting criteria,” according to Glenn Schultz, director of prepayment modeling at MUFG Securities.

For the agency mortgage-bond investor, there's no question about if you will get paid -- the American taxpayer bears all the default risk -- but when you will get paid. As any homeowner may refinance or pay off their mortgage at will and at par, this can hurt performance for those who purchased their bonds at a premium.

Prepayment speeds always bear close observation, and they have flat-lined since April between 30 to 35 CPR for Fannie Mae 30-year mortgage-backed securities, hitting their fastest since at least 2004 in September. Ironically, the very same Federal Reserve monetary policies which have poured over $1.6 trillion of support -- so far -- into the sector have also worked to create record-low mortgage rates, sparking a refinance wave.

A conditional prepayment rate (CPR) is a loan prepayment rate equivalent to the proportion of a loan pool's principal that is assumed to be paid off ahead of time in each period

Prepayment speeds have increased nine of the last 12 months, with the aggregate Fannie Mae 30-year speeds now over twice as high as the 14.8 CPR seen last January. However, this dramatic speed increase took place mostly in March and April, up 42% and 26%, respectively. Though speeds have remained within a tight range since April, according to Schultz, “investors should not expect a reprieve from fast prepayment rates” until late in the first quarter.

All the factors that have pushed speeds higher over the past three quarters remain in place. Almost the entire universe of borrowers have ample incentive to refinance with mortgage rates near record lows, lenders have ramped up capacity and the Fed has given no hint of slowing its massive monetary accommodation.

Furthermore, the Mortgage Bankers Association refinance applications index jumped over 11% in its latest report, and remains at a level 80% higher than its trailing average over the last decade.

“There is ample low-hanging fruit to pick there for originators,” Wells Fargo analysts Randy Ahlgren and Philip Hong wrote in a client note Friday. “The real test is the March print.”

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