Refinancing Spike to Keep Mortgage-Backed Security Investors on Guard

(Bloomberg) -- Home refinances jumped 39 percent during the week ended March 29, according to the Mortgage Bankers Association. With the index now at its highest level since Nov. 11, 2016, it’s likely investors will continue to look to protect themselves from rising prepayment speeds.

  • One way for mortgage-backed security investors to protect themselves from a surge in prepayments 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
Refinancing Spike to Keep Mortgage-Backed Security Investors on Guard

Key Insights

  • This spike in the refinance index is sure to keep concerns over faster prepayment speeds in the forefront of mortgage investors’ minds. “We expect this recent drop in rates to be reflected in both the April and May prepayment reports, mostly in May,” Scott Buchta, head of fixed income strategy at Brean Capital wrote in a client note
  • “The TBA deliverable in the 4 and 4.5 percent coupons remains extremely negatively convex and we expect dollar rolls to suffer as a result,” Buchta said
  • Low-loan balance specified pools for 30-year 4 and 4.5 percent coupons, which historically have seen relatively slower prepayments, have rallied 24/32 and 1-4/32, respectively, year-to-date, according data compiled by Bloomberg

Markets

  • The Bloomberg Barclays U.S. MBS index excess return versus Treasuries stands at -3 basis points month-to-date after lagging by 11 basis points in March. It was outperforming Treasuries by as much as 19 basis points on March 19 but lost its footing as the 10-year yield rallied to a year-to-date low close of 2.37 percent in the latter half of the month

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  • A sample of Street analysts have them all neutral or underweight on the mortgage sector, citing tight valuations and elevated prepayment risk
  • One of the negative technicals for the sector is heightened prepayment risk over the near term due to the recent rate rally. High gross weighted-average-coupon and streamline refinancings may increase speeds even for Fannie Mae 30-year 3.5 percent MBS, according to the latest weekly report from Nomura’s MBS analyst team
  • The low-loan balance specified pool for the 30-year 3.5 percent coupon has rallied 10/32 year-to-date, according data compiled by Bloomberg

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