MBA Refinance Index increases
Mortgage refinance applications, as measured by the MBA (Mortgage Bankers Association) Refinance Index, fell 2.3% from 2,104 to 2,056 for the week ending March 4. Since mid-2013, refinances have been dropping dramatically. Homeowners with home equity have already refinanced. Those left with high rates are underwater. However, there was a slight rebound because rates came back down.
The MBA reported that the share of refinance applications fell to 56.7%. Mortgage bankers were worried about the impact of the Fed’s rate hikes. They were surprised by the gift of a bond market rally. The hike should have raised mortgage rates and slowed the refinance activity. Slowing refinance activity is negative for originators including Wells Fargo (WFC) and JPMorgan Chase (JPM). Instead, the ten-year bond yield fell by 63 basis points since the Fed hiked rates in December.
Implications for mortgage REITs
Refinancing activity impacts prepayment speeds. This is a critical driver of mortgage REIT returns. Prepayments 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. The investor is forced to reinvest the proceeds in a lower-rate investment. This means lower returns going forward. A rise in prepayment speeds could be negative for 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 additional refinances will be driven more by home price appreciation.
REITs that invest in non-agency REITs such as Nationstar Mortgage (NSM) and Two Harbors Investment (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).