Weekly mortgage applications: Why you should pay attention (Part 4)

 

The MBA Refinance Index fell for the seventh straight week

The Refinance Index fell to 3.8% (to 2,247 from 2,336) even though the average 30-year fixed-rate mortgage was flat at 4.35%. The ten-year bond yield rose 8 basis points. The bond market has been re-adjusting to the idea that we may see the end of quantitative easing in fall. That said, it seems to have stabilized at these levels, at least for the moment.

(Read more: Radar Logic futures curve predicts flat real estate prices until September 2014)

MBA reported that the share of refinance applications dropped to 63%. Most originators are anticipating a more purchase-driven market going forward and believe we’ve seen the lows in interest rates. If we have in fact seen the lows in interest rates, home price appreciation will drive refinance activity more as previously underwater homeowners eventually get back to positive equity and take advantage of lower rates. Slowing refinance activity could be a negative for originators like PennyMac (PMT) and Redwood Trust (RWT).

(Read more: Bonds and REITs collapse on FOMC statement)

Implications for mortgage REITs

Refinancing activity affects prepayment speeds, which is a critical driver of mortgage REIT returns. Prepayment speeds occur because homeowners are allowed to pay off their mortgage early, without penalty, and when interest rates fall, those who can refinance at a lower rate do. This is good for homeowners. However, it isn’t necessarily good for mortgage lenders—especially REITs. When homeowners prepay, the investor loses a high-yielding asset and is forced to re-invest the proceeds in a lower-rate investment. This means lower returns going forward. A rise in prepayment speeds could negatively affect REITs, like American Agency Capital Corp. (AGNC), Annaly Capital Management, Inc. (NLY), Hatteras Financial Corp. (HTS), CYS Investments, Inc. (CYS), and Capstead Mortgage Corporation (CMO). That said, the increase in rates has basically put prepayment worries on the back burner for the REITs.

However, as rates increase, prepayments become less of a problem for REITs. But increasing rates bring their own set of problems, and REITs face mark-to-market hits on their portfolio and must adjust their hedges to a more volatile interest rate environment. Mortgage-backed securities outperform in stable interest rate environments, but they’re highly vulnerable to interest rate shocks.

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Weekly mortgage applications: Why you should pay attention (Part 1)

Every week, the Mortgage Bankers Association (MBA) puts out an index of mortgage application activity

Mortgage applications are relevant to a number of industries—from banks to non-banks, to mortgage REITs to homebuilders. This series will break down the different indices and help you learn what insight you can glean from them. If you’re a bank, you’re looking at these indices and trying to determine whether you’re competitive in all the segments you want to be competitive in. If you’re a non-bank, you might be looking to see if you’re gaining share or losing share. If you’re a mortgage REIT, you’re focusing on the refinance index and what it might mean for prepayments going forward. And if you’re a homebuilder, you’re watching the purchase index as a way to gauge future demand.

(Read more: Radar Logic futures curve predicts flat real estate prices until September 2014)

This series will look at the three main MBA indices.

We’ll start with the basic MBA Mortgage Applications Index.

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