The Mortgage Bankers Association Refinancing Index, a leading indicator of prepayment volumes, breached its first-quarter high as 30-year mortgage rates broke through and sustained sub-4 percent levels. While currently about 45 percent of 30-year mortgages are in the refinance zone, most of this prepayment risk remains concentrated in mortgages originated since 2018. This fast-paying subset of the mortgage universe, the rollout of single-security in June (a common single mortgage-backed security backed by issuance from both Fannie Mae and Freddie Mac), and the continued reduction in the Fed’s balance sheet holdings have all led to worsening performance of cheapest-to-deliver collateral and widening residential MBS valuations (RMBS). Conversely, less-negatively convex options, such as Agency multifamily bonds and better call-protected pools, have benefited. Looking ahead, the near-term technical picture remains challenging as supply picks up over the summer and incremental prepayment risk remains elevated. Despite these concerns, a dovish Fed and RMBS valuations near the widest levels of the year may provide a positive backdrop for the sector.
Prepayment Risk Rose as 30-Year Mortgage Rates Dipped Below 4 Percent
Mortgage Bankers Association Refinancing Index
The Mortgage Bankers Association Refinancing Index, a leading indicator of prepayment volumes, rose as 30-year mortgage rates broke through and sustained sub-4 percent levels.
Source: Guggenheim Investments, Bloomberg, Mortgage Bankers Association. Data as of 6.30.2019.
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 MBS holdings.
—Aditya Agrawal, CFA, Director; Louis Pacilio, CFA, Vice President
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