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MBS with significant refi incentives jumps to 75%

admin | March 6, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The 100 bp drop in US 10-year rates since mid-January has left nearly 100% of MBS trading at a premium to par and more than 75% of outstanding MBS in line for significant incentives to refinance. And if the 30-year mortgage rate available to borrowers moves toward 3.00% or below in the coming weeks and months, it should trigger the biggest refinancing wave since the announcement of mortgage QE in 2012.

The move in Treasury rates should eventually bring primary 30-year mortgage rates close to 3%, which would put nearly 75% of agency MBS pools at least 75 bp in-the-money to refinance (Exhibit 1). Primary rates typically lag sharp moves in Treasury rates. Originators often keep mortgage rates high to limit pressure on origination capacity and sell more loans at premium prices into the secondary market. The current spread between primary and secondary mortgage rates normally is around 100 bp but has recently jumped to 154 bp and beyond according to Freddie Mac’s most recent primary mortgage market survey rate.

Over time, the spread between primary and secondary should bring 30-year mortgage rates toward 3.00%, and this should push aggregate 30-year speeds to around 26 CPR on average. This is consistent with prepayments in late 2011 and early 2012, and the first few months of 2013. It is almost double the level in January 2020.

Exhibit 1: The latest drop in rates should eventually create significant refi incentives for 75% of MBS

Source: Amherst Pierpont Securities

With the approach of the spring and summer months, seasonal increases should push speeds even faster. If current rates hold, aggregate MBS speeds should reach around 30 CPR in June.

Aggregate speeds closely track the percentage of outstanding MBS with 75 bp of refinancing incentives (Exhibit 2). Markets with a similar share of outstanding MBS in-the-money showed some of the highest prepayments speeds of the last decade. Speeds averaged roughly 25 CPR in late 2011 and early 2012, and in early 2012. Speeds breached 30 CPR in late 2012.

Exhibit 2: The share of market 75 bp in-the-money ties closely with aggregate MBS prepayments

Note: The number printed inside each circle represents the % of the MBS universe that was >75 bp in-the-money to refinance that month. Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities

The primary/secondary spread jumped to record levels

Primary mortgage rates have not dropped as quickly secondary rates, and as a result the primary/secondary spread has jumped to the highest level since 2010 (Exhibit 3). Freddie Mac’s most recent primary mortgage market survey rate is 3.29%, which suggests that primary/secondary spreads have jumped to 154 bp.

Exhibit 3: The mortgage primary/secondary spread is the widest since 2010

Note: Primary/secondary spread is the difference between Freddie Mac’s weekly Primary Mortgage Market Survey rate and the 30-year mortgage current coupon averaged over Monday through Wednesday of the same week. Source: Freddie Mac, Amherst Pierpont Securities

A review of a few large lenders’ websites suggests they are holding interest rates even higher. For example, the 30-year refinance rate from some lenders is:

Wells Fargo: 3.875% with 0.5 points paid.
Chase: 3.49% with 1.0 point paid.
Quicken: 3.375% with 2.0 points paid.
Bank of America: 3.875% wth 0.933 points paid.

Adjusting for points paid to match the survey rate (0.7 points) suggests that all of these lenders are offering much higher rates than the survey suggests. The adjusted rates range from 3.68% (Chase) to 4.19% (Quicken), assuming a 1.6x multiple (derived from the FNCL 3.5% − FNCL 2.5% swap).

The Bankrate.com survey is much higher, currently 3.69%, but is heavily influenced by rates from the large banks. This suggests that smaller, non-bank, lenders are offering much more attractive rates to borrowers than the big lenders.

Rates for other products can vary dramatically. Wells Fargo, for example, is quoting 2.75% for a 30-year VA purchase loan. VA borrowers prepay very quickly when interest rates fall and may be much further in-the-money than conventional and FHA borrowers if the Wells Fargo rate is representative.

Next week’s refinance index could double

The primary/secondary spread increases because mortgage lenders are unable to quickly increase origination capacity when interest rates fall. When applications spike and capacity is reached, lenders can hold firm on rates and originate loans for very high profits. This relationship can be quantified by comparing the primary/secondary spread to the volume of refinance activity per mortgage loan broker (Exhibit 4).

Exhibit 4: Primary/secondary spreads increase when the number of applications per broker spike

Note: Data covers January 2010 through March 3, 2020. The primary/secondary spread is adjusted to account for increases in the average g-fee charged each year. Source: Bloomberg, U.S. Bureau of Labor Statistics, Amherst Pierpont Securities

The most recent refinance index covered application activity for the week ending February 28. Since then interest rates have fallen dramatically and the primary/secondary spread has widened 27 bp. If the relationship shown by the regression holds then the refinance index could double next week. This would surpass the post-crisis peaks in 2010 and 2012 (Exhibit 5).

Exhibit 5: The MBA refinance index is moving higher

Source: Mortgage Bankers Association

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