Drop in mortgage duration may drive spike in prepayments

by Candyd Mendoza10 May 2019

Interest rates pushing down the US MBS index duration might lead to a surge in refinancings, according to a Bloomberg article.

“Duration, a measure of a security’s price sensitivity to a change in interest rates, will drop on the assumption that principal payments on that bond will be received earlier than previously expected,” Bloomberg wrote. “That’s what happens with mortgage-backed securities as rates decline since homeowners are then expected to increasingly refinance into lower mortgage rates and pay off their previous loans.”

The Bloomberg Barclays US MBS index duration went down from 4.47 years on April 22 to 4.15 years at present. However, the index remained above the year-to-date low of 3.84 on March 27, according to Bloomberg’s compiled data. Its trailing one-year average now sits at 4.94 years.

“While prepayment speed [has] shown increases of over 20% in the last two monthly reports, this was thought to be transitory as rates had risen throughout much of April,” Bloomberg wrote. “Now, however, a renewed rally that has seen the US 10Y yield drop to its lowest level since March 29, and the Freddie Mac 30-year mortgage rate fall for the first time in five weeks, may continue to spark refinancings if sustained.”