Are lower rates helping mortgage originators? (Part 4 of 4)
The MBA Refinance Index increases
Mortgage refinance applications, as measured by the Mortgage Bankers Association (or MBA) Refinance Index, rose 0.5% from 1,862 to 1,870 as the spike from late January evaporated. Since mid-2013, refinances have been dropping like a stone, as the people who have home equity have already refinanced, and the ones left with high rates are underwater.
The MBA reported that the share of refinance applications increased to 61.5%. This is a drop of 10 percentage points from a month ago. This bond market rally caught many by surprise, but it was a welcome surprise for mortgage originators who had a horrendous 2014 and were expecting the normal slow January and February. 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, which are a critical driver of mortgage REIT returns. Prepayment speeds occur because homeowners are allowed to pay off their mortgages early, without penalty, and when interest rates fall, those who can refinance at a lower rate do. This is good for homeowners. But 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 a large exposure to fixed-rate, government-guaranteed mortgages such as American Capital Agency Corp. (AGNC) and Annaly Capital Management (NLY).
Investors interested in gaining access to the mortgage REIT sector as a whole should look at the iShares Mortgage Real Estate Fund (REM). Investors interested in trading the financial sector should look at the S&P Financial Select SPDR ETF (XLF).
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