Dallas, Texas 09/10/2013 (Financialstrend) – Last week the Refinance Index dropped to 2.3%, with the bond market being in a quiet mode. The bond market has been trying to readjust itself to the fact that the fall might just herald the end of QE. At the moment however, these are the levels that it has plateaued at, well at least for the present.
The MBA reported that the refinance-applications shared dipped to 63%. A larger percentage of originators are expecting a largely purchase-driven market in the future. The belief also is that the interest rate troughs have already been lived and will be a thing of the past. If that is truly the case, the appreciation in home prices will drive refinance activity further as those homeowners who were underwater earlier will move back into the positive equity zone. These are the people who will eventually take advantage of these lower rates.
The prepayment speeds of mortgage REITS such as Capstead Mortgage Corporation (NYSE:CMO) are affected by refinancing activity. These speeds occur as homeowners are permitted early repayment of their mortgages without any penalty whatsoever. The drop in interest rates also prompts people to refinance which is a definite plus for homeowners. But CMO and other mortgage REITS like Annaly Capital Management, American Agency Capital Corp, Capstead Mortgage Corporation and the likes tend to suffer.
The pressing need
Whenever a homeowner prepays his/her mortgage loan, in effect, the investor loses out on a high-yielding asset and they are compelled to reinvest the proceeds into any investment with a lower rate. Very simply, this means lower returns. Thus any rise in prepayment speeds might have a negative impact on mortgage REITS. The rise in rates has typically pushed all prepayment worries into the shadows for these REITS.
These REITS now have to address mark-to-market hits on their portfolios and have to make an adjustment to their hedges to the added volatility in the interest-rate environment. In a stable interest rate environment, the mortgage backed securities tend to outperform, but interest rate shocks affect them adversely.