Effects of Refinancing on Mortgage Markets

BR is Bullish on Resi Credit: The U.S. residential mortgage market is $14T. When a mortgage is out-of-the-money, the loan trades below par and the prepayment rate is ~3% CPR which means only 3% pre-pay per annum (i.e., owner moves, extra cash flow, death), a low prepayment rate. When mortgage rate fall, homeowner who are in-the-money by 75bs are likely to refinance, CPR jumps to 20%+ given homeowners seek to lower their monthly payment. It’s wonderful news for homeowners, but for those who own premium coupon MBS they are subject to negative convexity. Convexity measures the sensitivity of a bond's price to changes in interest rates. Bonds with positive convexity benefit commensurately to a decline in rates as future cash flows are discounted at a lower rate, making them more valuable. MBS on the other hand have negative convex when the price approaches par as the investment doesn't increase as much from this inflection point due to prepayment risk rising as the bondholder loses the opportunity to earn the higher interest payments and then must reinvest at lower rates. The bar chart below shows the rate distribution for the mortgage universe. As the mortgage rate is now 6.1%, mortgages >6.5% are highly susceptible to early pre-payment. MBS between 5% - 6%, might see prepayments inch up marginally from 3% CPR to 4% as these slightly out-of-the-money homeowners who have felt trapped, now have more flexibility to move since the cost to do so is marginalized. Note that in the U.S., 30-year fixed rate mortgages are priced at spread to 10-year UST (not SOFR or Fed Funds); I expect the 10-year UST rates will decline less than the front end of the curve as the yield curve steepens as the Fed cuts rates. New home sales will benefit in this lower rate environment as will existing homes sales. Be Bullish: lower mortgage rates are net-positive for homeowners/residential credit, home builders, building materials, and mortgage originators.

In the week ending August 02, 2024: The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances decreased to 6.55% from 6.82%. Mortgage rates are at the lowest level since May 2023. The spread between the 30-year fixed-rate mortgage and the 10-year Treasury yield declined to 2.51 percentage points. Mortgage rates are down 74 basis points from the 2024 peak. The result? A little refi boomlet! The seasonally adjusted refinance index increased nearly 16% from the previous week. The refinance index remains 59% higher compared to the same week one year ago. The refinance share of mortgage activity increased to 41.7% of total applications from 38.2% the previous week. The seasonally adjusted purchase index increased a modest 0.8% from one week earlier, but remains 10.7% lower than the same week one year ago. Average purchase mortgage applications in the first week of August have decreased 3% compared with the month of July, and remain nearly 9% lower compared to one year ago. But it's still early in the month. Why such a sluggish pickup in purchase applications despite the decline in rates? Well, rates declining from 6.75% to 6.5% only results in a 1 percentage point increase in the share of renters who could afford the median-priced home. Affordability remains constrained, and while inventory has picked up, it's still historically low.

Bloomberg Intelligence https://lnkd.in/eZM6Fnn5 The spread between primary mortgage rates for consumers and the secondary MBS current-coupon yield has declined as mortgage bankers finally appear to have cut enough costs to return to profitability. Lower primary rates could improve purchase loan demand, increase net supply and spur more refinancings. Elevated volatility as markets await a shift in Federal Reserve policy may keep pipeline hedging costs elevated, for now, which may hold up further primary/secondary spread tightening. Furthermore, if rates do fall far enough to trigger another refinancing wave, now-limited originator capacity could also contribute to wider primary/secondary spreads. In any case, primary/secondary spreads are unlikely to return to pre-GFC levels, given higher guarantee fees and loan level pricing adjustments and other Dodd-Frank-related requirements that were implemented in response to the 2008 crisis. #mortgage #mbs #fixedincome #banking

Dear Mortgage Industry, Originators- this is for you. Be alert and proactive, not too early, but not too late regarding mortgage rates decreasing and future refinance opportunities. Many buyers who secured a loan/interest rate from 2022 to the recent decline might benefit from refinancing, but not so fast. The first step is notifying and quickly producing the data. Have templates created to show the benefits and the recapture analysis. Explain what is also anticipated with the economic changes, which seem somewhat inevitable when inflation comes down to avoid anything premature. Create templates (now) for all those who may benefit from obtaining the information you need on their existing loan terms. Save these custom scenarios in your pricing engine to compare new terms for quick updates and consistent input. This will inform borrowers of their options and when they (not you) wish to act on opportunities. Find those potential opportunities now, but understand that things will be volatile. Never allow emotion to impact math and facts. Some are consistently busy or active, and I understand some are slow or verging on desperate... but desperation has no place in this industry as licensed professionals when coaching a client or potential borrower on refinance timing as you don't want to be premature on more significant savings potentially ahead. Some reminders as this is a unique territory after the market we were in: - Mind and respect EPO's - Mind and respect the borrower's equity - Understand and educate on investor's float-down policies - Provide choices on all rate coupons and share the full rate sheet for analytics on recapture math so the borrower is educated and has financial options. NEVER quote one random rate coupon or miss 'all' fees and costs/credits associated with any new loan. - Share market trends and data. Speculation is part of that but produces choices and financial impact on every borrower - Discuss the pros and cons of financing closing costs or refunded prepaids - Discuss all consumer debts for consolidation opportunities and savings - Closely monitor economic reports and track MBS daily - Be fast, accurate, and organized on all updates #future #refinancing #mortgage #data #recapture #math #ethics