Some homeowners are beginning to refinance their residential mortgages faster than expected in response to falling long-term interest rates, causing a chunk of the $5 trillion in mortgage-backed securities to slump in secondary markets.
Prepayments on 30-year fixed-rate loans, the return of principal when a loan is refinanced or withdrawn from the MBS, jumped nearly 30% last month, Fannie Mae and Freddie Mac said late Thursday. That was well above forecasts of a 20% rise, though was focused on newer loans with lower interest rates to borrowers with better credit, according to strategists at Morgan Stanley and Credit Suisse.
The risk to Annaly is that bonds they are holding that trade above par will be redeemed at par. From the Annaly 10-K
An increase in prepayment rates may adversely affect our profitability....when borrowers prepay their mortgage loans at rates that are faster-than-expected, this results in prepayments on mortgage-backed securities that are faster than expected. These faster than expected prepayments may adversely affect our profitability....While we seek to minimize prepayment risk to the extent practical, in selecting investments we must balance prepayment risk against other risks and the potential returns of each investment. No strategy can completely insulate us from prepayment risk.
I believe the discount to book value gives one a margin of safety in Annaly. I currently don't own the shares but would likely repurchase the shares if they dipped to last week's lows. I look forward to hearing more about Annaly's prepayment risk on the earnings conference call.