The Mortgage Bankers Association Refinancing index, a leading indicator of prepayment volumes, is rising again as 30-year mortgage rates declined. While about 50 percent of mortgages are in the refinance zone, the most sensitivity to prepayment risk is concentrated in generic mortgages originated since 2018 by non-bank originators.
Low Mortgage Rates and High Refi Volumes Have Kept Focus on Prepayments
Mortgage Bankers Association Refinancing Index
The Mortgage Bankers Association Refinancing index, a leading indicator of prepayment volumes, is rising again as 30-year mortgage rates declined.
Source: Guggenheim Investments, Mortgage Bankers Association, Bloomberg. Data as of 9.30.2019.
These were created in the new era of automation and digitization that eases the approval process and makes streamlined refinancing possible. This is most pronounced in mortgages originated through broker channels. This fast-prepaying subset of the mortgage universe, and the continued reduction in the Fed’s balance sheet holdings, have led to deteriorating performance of worst-to-deliver collateral and cheapening of residential MBS valuations. Conversely, less-negatively convex options, such as Agency multifamily and better call-protected pools, have benefited. Looking ahead, the near-term technical picture remains challenging as supply remains high, incremental prepayment risk is elevated, and demand is uncertain. Despite these concerns, RMBS valuations near their cheapest levels in recent years may provide a positive backdrop for the sector.
The Bloomberg Barclays U.S. MBS index posted a 1.37 percent total return as mortgage rates fell and interest rate volatility picked up in the third quarter. Option-adjusted spreads were slightly wider over the quarter and are currently near the widest levels of the past six years.
We continue to favor investments where either the collateral or structure offers some cash flow stability at reasonable spreads. Accordingly, we find select subsectors attractively priced in the current environment, including longer-maturity Agency multifamily, better call-protected pools, and some collateralized mortgage obligation structures. These investments have performed well, and we expect them to continue their performance in scenarios where interest rate volatility rises, interest rates decline sharply, or the Fed continues down the path of reducing its Agency MBS holdings.
—Aditya Agrawal, CFA, Director; Louis Pacilio, CFA, Vice President
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