Flatter Yield Curve Could Vex Prepay Analytics.

After a year notable for defying historical precedent on the prepayment front, the market faces growing uncertainty with the prospect of flattening interest rates, according to a Bear Stearns & Co. review-and-outlook analysis.

In the January issue of Short-Term Prepayment Estimates, analysts Dale Westhoff and V. S. Srinivasan noted that the speeds of mortgage-backed securities ran counter to the conventional wisdom in several areas last year.

For example, Ginnie Mae MBS prepaid faster than conventionals and expanded-criteria loans prepaid faster than prime loans, they said.

Pointing to the "bearish flattening interest rate scenario" now facing the market, the analysts said this scenario "brings into question the viability of the current housing market, current home prices and, ultimately, current MBS prepayment assumptions."

In addition, the uncertainty is magnified by the fact that prepayment models must hark back to the 1999 and 2000 experience to try to forecast future prepayments because "it has been four years since a discount dominated, non-refinance MBS market even existed," the Bear Stearns analysts said.

The key rate/refinancing threshold in the coming months is "the 5.60% to 5.40% mortgage rate corridor," they said, reporting that MBS refi exposure jumps from 35% at the former level to 65% at the latter.

According to the analysts, most of the recent changes in prepayment behavior can be linked to three external factors: record home price growth, expanded access to credit, and the growth of products targeting "affordability."