Mortgage investors will carry unpleasant memories of this year's surging prepayment speeds, yet as the calendar flips there appears little chance of near-term relief.
The 30-year mortgage rate is at at a record low, and for the most creditworthy borrowers the rate is oftentimes even less. This has driven prepayment speeds on Fannie Mae 30-year mortgage bonds 117% higher year-to-date -- their fastest since at least 2004. Speeds on Ginnie Mae 30-year bonds have increased 52% over the same time frame, according to data compiled by Bloomberg.
While this has been a boon for American homeowners who have lowered their mortgage payments by refinancing, it keeps bond investors up at night.
In October, aggregate Fannie Mae 30-year speeds increased to a conditional prepayment rate of 36.9. This means that should the current level hold, about 37% of the principal balance within those mortgage-backed securities will be prepaid annually. With homeowners paying off their mortgages at par and Fannie 30-year MBS trading at a premium, performance for investors can suffer.
Mortgage rates would need to leap about 0.50% higher in order to begin to crimp this flow of prepayments.
"The critical threshold for mortgage rates is 3.25% to 3.375% to see refinancings slow," Scott Buchta, head of fixed-income strategy at Brean Capital LLC, said in an interview. About 80% of the universe of borrowers currently have incentive to refinance, he added.
The Federal Reserve's latest round of quantitative easing has focused on mortgage bonds to the tune of just over $1.3 trillion in purchases since March -- a policy that helps keep lending rates low. In combination with moving the Fed funds rate back to 0% again, any near-term dramatic increase in mortgage rates seems unlikely.
In addition, mortgage lenders are earning hefty profits on loans now, and any increase in Treasury yields will likely just cut into their earnings instead of lifting consumer mortgage rates. The primary/secondary spread, which measures the difference between where the lender can sell a home loan into the market and where they will offer one to a homeowner, sits at 1.55% as of Wednesday in New York. This is well above the trailing five-year average of 1.06%.
"There has been a huge influx of capacity in the lending industry," said Walt Schmidt, head of mortgage strategies at FHN Financial in Chicago. "Along with increased use of technology and policies such as appraisal waivers, this has pushed the sector toward faster prepayments."
So over the coming months it is likely that fast prepayments will continue. JPMorgan Chase & Co. analysts summed it up following the most recent speed report, noting that the outlook "over the next few months is more glum than it appeared a month ago."
The coming year, at least its start, is unlikely to provide any relief.
"Unless we back up 0.50% in mortgage rates, faster speeds are here to stay," Schmidt said.