Analysts See Refinancing Rate Slowing Down.(mortgage backed securities)

Several prepayment trends in the discount mortgage-backed securities sector are likely to reverse in the coming months as the housing sector continues to cool down, according to Bear Stearns & Co.

Writing in the February issue of Short-Term Prepayment Estimates, analysts Dale Westhoff and V. S. Srinivasan noted that less than 12% of the mortgage universe was still refinanceable around the beginning of the year, with 75% at or below the 5.5% coupon.

Over the past five years, prepayment behavior in the discount sector has in some ways been "turned upside down" by surging home price appreciation, they said.

"With a clear inflection point reached in the housing cycle, we expect many of these relationships to begin a reversal process creating some of the best trading opportunities in 2006," the Bear Stearns analysts said.

For example, speeds on discount MBS pools backed by loans with high loan-to-value ratios are likely to slow significantly, the analysts predicted.

High-LTV discount pools have been prepaying faster than usual in recent years, in part because they are backed by financially weaker borrowers more likely to tap their home equity through cash-out refinancings when home prices rise, according to the analysts.

In addition, rapid home price appreciation has allowed many high-LTV borrowers to eliminate mortgage insurance payments ahead of schedule by refinancing and thereby reducing LTVs to 75% or below, which permits them to cancel the MI, they said.