MBA Refinance Index falls
Mortgage refinance applications, as measured by the MBA (Mortgage Bankers Association) Refinance Index, fell 2.4% from 2,189 to 2,136 for the week ending June 24, 2016. 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 interest rates have fallen again.
The MBA reported that the share of refinance applications rose to 58.1%. Mortgage bankers entered 2016 worried about the impact of the Fed’s (Federal Reserve) rate hikes. They were surprised by the gift of a bond market rally and more recently by Brexit. The rate hike should have raised mortgage rates and slowed refinance activity. Slowing refinance activity is negative for originators including Wells Fargo & Company (WFC) and JPMorgan Chase (JPM). It’s hard to believe the ten-year bond yield has fallen by 80 basis points since the Fed raised rates six months ago.
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. These include 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 Holdings (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 can look at the iShares Mortgage Real Estate Capped ETF (REM).