Do Shorts Suggest End to Refi Boom?

After two years of record-breaking loan production, publicly-traded mortgage firms could be in for a shellacking, right?

Not exactly, but that hasn't stopped speculators from increasing their bets against residential finance-related firms.

According to data compiled by Dow Jones & Co. and Mortgage Servicing News, short positions in mortgage stocks increased significantly this fall.

From mid-September to mid-October, shorts in subprime giant New Century Financial, Irvine, Calif., jumped 84%.

Meanwhile, speculators are targeting another subprime lender, NovaStar Financial, Westwood, Kan. Shorts in NovaStar jumped by 67% from September to October.

Other mortgage related firms that experienced an increase in short positions: Freddie Mac (up 27%), Fannie Mae (up 26%) and Household International (up 16%).

These figures were posted as Mortgage Servicing News went to press with its December/January edition. It's possible that short sellers might take into account the 50 basis point cut in rates by the Federal Reserve in November and begin "covering" or reversing their positions.

Short sellers make their money by borrowing shares at what they feel is an inflated price. They then sell those borrowed shares immediately with the hope of replacing them later on after the stock has fallen in price.

The difference between what they borrowed the shares at and the price they pay to replace those borrowed shares is their profit or loss.

After two great years for loan production - $2.06 trillion last year and a likely $2.3 trillion in 2002 - some short sellers are operating under the assumption that refis may end soon and along with it stellar mortgage profits.

However, predicting an end to refis is never easy. In mid-November, Morgan Stanley & Co. released a report predicting that 90.6% of outstanding mortgage-backed securities ($2.5 trillion) are refinanceable.

In an interview with MSN, Morgan analyst Ken Posner said he thinks the industry could produce $2 trillion in loans in 2003.

Morgan Stanley bases its refi estimate "on the assumption that current spreads between mortgage rates and 10-year Treasuries are 200 bps and that mortgage rates are 50 bps above MBS coupons. The size of the refi market will depend on how long rates stay at these levels," the report says.

Mr. Posner made it clear that his refi estimate applies to MBS, and not necessarily all outstanding mortgage debt, which according to the Quarterly Data Report, totals about $6.1 trillion.

Morgan Stanley, in its report, notes, "Though it may look like cash-out refis dropped from Q2, that is not the case ... The incentive to take cash out may increase as mortgage rates level off."

Copyright c 2002 Thomson Media. All Rights Reserved.

Next in News ►