By the Numbers
Refinance risk rising in 30-year MBS
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Lower rates following the Trump administration’s tariff announcement last Wednesday increased the refinance risk in 30-year conventional 6%- and 6.5%-coupon MBS but have not dropped enough to affect 5.5%s. Mortgage rates available to homeowners need to fall to around 6% to start attracting refinances from borrowers in the 5.5%-coupon pools. Most of the mortgage universe is in MBS with very low coupons, so it would take a significant rally to trigger a massive refinance wave. But lower rates could encourage some additional homebuying from those low coupon borrowers.
More than 25% of loans in 30-year 6% pools could currently lower their rates by at least 75 bp by refinancing, up from close to none at the end of January (Exhibit 1). In 30-year 6.5%s pools more than 80% are at least 75 bp in-the-money, a big jump from roughly 40% two months ago. Speeds in both coupons should accelerate. The MBA’s refinance index had been edging slower over the last couple of weeks as mortgage rates held steady but should rebound higher.
Exhibit 1. More FNCL 6% and 6.5% borrowers are deep in-the-money.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
Mortgage rates dropped in February, lifting speeds on higher coupons throughout March (Exhibit 2). This shows daily prepayment speeds through March 28, just three days shy of the end of the collection cycle. FNCL 6.5%s and 7.0%s showed the strongest reaction, while FNCL 6%s were only slightly in-the-money and didn’t respond much. That should change during April if rates stay at these levels or lower.
Exhibit 2. Speeds are increasing following the February rally.
Daily prepayment collections are annualized to a CPR-scale.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
Most outstanding MBS have very low coupons, so that even a 2% 10-year Treasury and roughly 4% mortgage rate would only put about 27% of borrowers deep in-the-money to refinance (Exhibit 3). A borrower is considered deep in-the-money with a 75 bp rate incentive, since that is typically sufficient to make a refinance worthwhile after covering closing costs. Each point shows the in-the-money percentage and rough expectations for aggregate speeds.
Exhibit 3. Most MBS are still deep out-of-the-money.
Source: Fannie Mae, Freddie Mac, Bloomberg, Santander US Capital Markets.
The largest coupons produced after the pandemic are 5.5%s and 6.0%s (Exhibit 4). These borrowers have never had much opportunity to refinance, so if rates do get low enough there should be a strong prepayment response in those coupons.
Exhibit 4. Percent in-the-money for largest cohorts at different mortgage rates
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
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