MBA Refinance Index increases
Mortgage refinance applications, as measured by the MBA (Mortgage Bankers Association) Refinance Index, rose 16.7% from 1,693 to 1,902 for the week ending August 28. Since mid 2013, refinances have been dropping dramatically. Homeowners with home equity have already refinanced. Those left with high rates are underwater. However, there has been a slight rebound because rates came back down.
The MBA reported that the share of refinance applications increased to 58.7%. The bond market rally of late 2014 and early 2015 caught many by surprise. It was a welcome surprise for mortgage originators, who had a horrendous 2014. Slowing refinance activity was a negative for originators, including Wells Fargo (WFC) and JPMorgan Chase (JPM).
Implications for mortgage REITs
Refinancing activity affects prepayment speeds—a critical driver of mortgage REIT returns. Prepayment occur because homeowners are allowed to pay off their mortgages early and without penalty. 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 reinvest the proceeds in a lower-rate investment. This means lower returns going forward. A rise in prepayment speeds could negatively affect REITs, especially those with large exposure to fixed-rate, government-guaranteed mortgages, such as American Capital Agency (AGNC) and Annaly Capital Management (NLY). That said, prepayment burnout has been relatively pronounced at these interest rate levels. Any further refinances will be driven more by home price appreciation.
REITs that invest in non-agency REITS such as Nationstar Mortgage Holdings (NSM) and Two Harbors Investment Corp (TWO) might find that swapping credit risk for interest rate risk is a good idea. Investors interested in gaining access to the mortgage REIT sector as a whole should look at the iShares Mortgage Real Estate Fund (REM).