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Mortgage Bond Market on Edge After a Spike in Home Refinancings

Mortgage Bond Market on Edge After a Spike in Home Refinancings

(Bloomberg) -- A spike in home loan refinancing, falling mortgage rates and newer collateral sporting prepayment red flags have increased prepayment concerns among mortgage-backed securities investors.

The latest refinance index report from the Mortgage Bankers Association showed the index at 1289, its highest since Feb. 2, 2018. While this is still low from a historical standpoint -- the trailing five-year average is 1496 -- the index is 14 percent higher from a year ago and 77 percent higher year-to-date.

This increase has come about as mortgage rates have dropped in tandem with Treasury yields, giving homeowners more incentive to refinance. The Freddie Mac 30-year rate has dropped to 4.06 percent from 4.94 percent as recently as November.

“The grind lower in rates has brought faster prepayment speed concerns to the forefront of conversations,” Megan Kesselman, a director at INTL FCStone Inc., said in a interview with Bloomberg News.

Mortgage Bond Market on Edge After a Spike in Home Refinancings

After years of zero-interest rate policy from the central bank and historically low mortgage rates that led to about 90 percent of the mortgage universe having no incentive to refinance, the conventional 30-year 4.5 percent MBS are now "under the prepay spotlight," Bank of America Corp. MBS strategist team led by Satish Mansukhani wrote in a recent report.

This is particularly true of the more recent vintages with their high loan sizes, prime credit scores and wide spread between their mortgage rate and the underlying coupon, sending investors in search of ways to reduce their risk.

One way is through purchasing “specified pools” -- bonds created using borrower characteristics such as credit scores or loan size -- designed to provide more certainty on when the underlying mortgages will be paid off. Those which have exhibited relatively slower prepayment speeds, such as 100 percent New York specified pools for 30-year 3.5, 4 and 4.5 percent coupons, have rallied by 10, 11 and 18 ticks, respectively, year-to-date, according to data compiled by Bloomberg.

While the 4.5 percent coupon in aggregate has seen speeds increase to 9.3 CPR from 8.2 at the end of 2018, the most recent 2018 vintage pools have seen an increase to 9.4 CPR from 5.7 over the same period. In addition, the latter’s weighted average loan age is now at seven months, the point where traditionally mortgage prepayment speeds tend to ramp up higher.

Constant Prepayment Rate (CPR): (or “Conditional Prepayment Rate”): The annualized percentage of the existing mortgage pool expected to prepay in a year

"Pay ups continue to appreciate, but demand for prepay protection has persisted. This trend should continue given worsening of the TBA float and the distinctly high weighted average coupon in newer production paper," said Kesselman.

Mortgage Bond Market on Edge After a Spike in Home Refinancings

To contact the reporter on this story: Christopher Maloney in New York at cmaloney16@bloomberg.net

To contact the editors responsible for this story: Christopher DeReza at cdereza1@bloomberg.net, Allan Lopez

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