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Prepayment Data Shows Refinancing Turning Flat in January

The speeds of Fannie Mae and Freddie Mac mortgage-backed securities slowed across the board in the January reporting period, producing "the flattest refinancing curve we have observed since early in 2001," according to the Bear Stearns Prepayment Commentary.

Speeds of Fannie Mae MBS were "marginally slower in the massive 5.0% and 5.5% coupons," whereas coupons of 6.0% and higher recorded declines of 17%-20% (representing decreases in constant prepayment rates of 5-10 CPR), said Bear Stearns analysts Dale Westhoff and Bruce Kramer.

"After today's report, we find all 6.0% issues now paying in the low to mid-20 CPR range and all higher coupons paying in the 35 to 45 CPR range," the analysts said. "Many of these issues are now more than 40 CPR below their peak levels from last summer."

Noting the recent drop in mortgage rates, the Bear Stearns analysts predicted that speeds will rise in the February and March reporting periods, but that "we expect this mini-refinancing event to be short-lived and centered primarily in new 5.5% and 6.0% issues."

Picking up on an observation from their previous commentary, Mr. Westhoff and Mr. Kramer pointed to the "remarkably strong prepayment levels" of 30-year 5.0s and 5.5s compared with historical speeds under similar circumstances.

The speeds of the 5.5% MBS coupons in January stood at 9.8 CPR for the 2003 Fannie Mae vintage, 14.7 CPR for the 2002 and 18.8 CPR for the 2001. Among Freddie Macs, the comparable speeds were 8.2 CPR, 13.1 CPR and 16.4 CPR.

"We believe several factors are contributing to this behavior - continued strength in the housing market that has increased baseline housing turnover levels, the continued attractiveness of hybrid ARMs as a refinancing vehicle for marginally refinanceable loans, and a heavy concentration of refinanced loans that dominate 2002 and 2003 production [this increases borrower tenure and the level of equity that borrowers have in their properties]," the analysts said.

In the February 2004 issue of Bear Stearns' Short-Term Prepayment Estimates, analysts Westhoff, Kramer and V. S. Srinivasan note that the "massive redistribution" in mortgage coupons in 2003 shifted the concentration of outstanding mortgages from the 6.5% coupon to the 5.5% coupon.

As a result, the 5.5% coupon "becomes the key driver of supply, duration and convexity hedging in the mortgage market," the analysts said.

Their analysis concluded that the recent low of 5.65% in 30-year mortgage rates had increased refinancing exposure from 41% to 50% of the market. "However, if this rate approaches 5.40%, the market refinancing exposure jumps to approximately 70% as the 5.5% coupon becomes fully refinanceable," they said.

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