The current refinancing wave surging through the U.S. mortgage market will push prepayment speeds to record levels for at least three more months as originators scramble to process the deluge of refinancing applications, which hit a record level in the latest week.
That is the word from mortgage strategists following an 11.6% surge in refinancings.
The surge “reflects that mortgage rates have dropped below 6% for the first time, and borrowers have responded,” said Dale Westhoff, the head of mortgage research at Bear, Stearns & Co.
In its weekly survey, the Mortgage Bankers Association reported that its seasonally adjusted refinance index rose to a record 6,671.4, from 5,977.2 in the previous week. The association’s purchase index, meanwhile, dipped to 359.4, from 359.7.
The percentage of applications for refinancing rose 2 percentage points, to 76.9%, the trade group reported.
The projections for this month’s prepayment speeds “are in record territory,” said Mr. Westhoff, who expects mortgages with a 6% coupon to hit a constant prepayment rate in the mid-40s. He also said that he expects mortgages with 6.5% coupons to reach a prepayment rate higher than 60% and those with 7% coupons to surpass 70%.
The only mortgages outside the pull of the refinancing undertow are those that were taken out very recently and are backed by the 5.5% coupon mortgage-backed securities pool. The most recent mortgages, which already reflect record-low rates, would become vulnerable to prepayment risks only if rates drop even further.
Fannie Mae and Freddie Mac are scheduled to release their September prepayment speeds late Friday, while the Government National Mortgage Association will release its data early Monday.
The question remaining for strategists is how fast originators can process the record number of applications. Many expect a “significant backlog” that will keep prepayment speeds historically high for up to nine months.
“The next three months of fast speeds are locked in at this point,” because it will take originators at least that long to process the applications that have already been filed, said Alec Crawford, the head of mortgage strategy at Deutsche Bank. “Beyond that, it depends on interest rates.”
A depressed stock market, the possibility of a U.S.-led war with Iraq, and an uncertain economic outlook have driven interest rates to levels not seen since the 1950s. Mortgage rates have fallen in tandem with the interest rates and have prompted homeowners to shed their old and not-so-old mortgages for new ones with lower financing costs.
As a result, trading in the secondary market, where mortgages are bundled together and sold as mortgage-backed securities, has been dominated by securities with lower coupons.
Investors who have had their higher-coupon securities called when homeowners refinance have been pumping the cash back into the mortgage-backed securities market, and they will probably continue to do so, strategists say.
“The vast majority” put their cash back into mortgages, and that has “allowed mortgages to trade at what we consider expensive levels,” Mr. Crawford said.
Many in the market view mortgages as safe-haven instruments offering a higher yield than Treasuries. In addition, many funds are dedicated to mortgage-backeds.
