The Long and Short
Corners of protection from slower prepayment speeds
Brian Landy, CFA | October 5, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Prepayments in 30-year MBS dropped a sharp 22% in September, landing almost right on expectations. A large drop in business days—four fewer in September than in August–already implied a 17.5% decline. Weaker seasonal housing turnover dragged speeds even lower on lower coupons. October speeds could rebound up to 5% as 3.5 additional business days competes with higher interest rates. Speeds should slow substantially through the fall and winter, possibly getting as low as 5.0–6.0 CPR in January 2019. As speeds cool, concern about extension should heat up, but a couple of corners in MBS offer protection.
- Discount Ginnie Mae pools, which continue to prepay much faster than comparable conventionals
- Discount MHA pools where rising home prices continue to bring down LTVs and allow borrowers, who have been in their homes longer than average, to move with a diminishing loss or none at all, and
- Discount loan-balance pools, where turnover tends to run higher than average
The Fannie Mae and Freddie Mac numbers
Fannie Mae 30-year aggregate speeds slowed 21.8% to 8.1 CPR from 10.3 CPR, the lowest print since 2008. Premium coupons slowed a bit less, since these loans are less sensitive to seasonal changes in housing turnover. Newer 2017 and 2018 vintage cohorts tended to slow less than more seasoned cohorts.
Freddie Mac 30-year aggregate speeds were almost identical to Fannie Mae’s, falling 22.5% to 8.1 CPR from 10.3 CPR and moving similarly to Fannie’s prints across the coupon stack and in individual cohorts.
Exhibit 1: Fewer business days pushed speeds slower across the stack
Purchase origination slows
Purchase issuance dropped in September, coming in 9% lower than in August. However, cash out and rate/term refinance volumes were relatively unchanged. This suggests that slower than expected speeds in August were due to a drop in prepayments due to housing turnover. Cash out and rate/term volumes have been relatively steady since June after falling heavily throughout the first part of the year.
Ginnie Mae speeds fall slightly less than conventionals
Ginnie Mae speeds slowed a little less than conventionals, with both Ginnie I and II programs slowing 18% overall. The difference was due to much stronger prepayments in the 2018 vintage, which actually prepaid faster in September across the stack. For example, Ginnie II 3.5%s 2018 increased 3.0% to 5.8 CPR while Fannie’s slowed 16.3% to 3.9 CPR.
Overall discount Ginnie Mae pools are prepaying much faster than comparable conventional pools. This is true of every large cohort with a coupon less than or equal to 3.5%.
Prepayment speeds should slow throughout the fall and winter months due to significantly higher interest rates and seasonally lower housing turnover. The MBS current coupon is nearly 40 basis points higher than on September 1 and 20 basis points higher since October 1. However, speeds could rebound slightly (up to 5%) in October as day count increases by 3.5 days and competes with higher rates. But the following months should be progressively slower as speeds fuller react to higher rates and housing turnover continues to slow. The combined effect could lower aggregate speeds by as much as 2 CPR in December and 3 CPR in January, which typically exhibits the lowest rates of housing turnover.
Exhibit 2: Prepayment summary
Exhibit 3: Agency speeds, largest cohorts
Exhibit 4: Mortgage rate forecast
Exhibit 5: Fannie Mae short term forecast
Exhibit 6: Freddie Mac short term forecast
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