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MBS: Inexpensive extension protection in MHA pools
admin | August 17, 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. This material does not constitute research.
Making Home Affordable or MHA pools promise some inexpensive extension protection as home price appreciation and amortization have lowered mark-to-market LTVs below 80%. These borrowers were initially constrained from prepaying due to home price depreciation during the housing crisis, which suppressed housing turnover below its normal level. Subsequent appreciation has unlocked this pent-up turnover and pushed speeds faster than the cohort, which is already prepaying faster than TBA pools. Faster speeds should lift performance in pools trading below par.
Discount MHA pools have prepaid faster since early 2017
Since early 2017, discount pools of all four MHA categories—loans with maximum original LTVs of 90, 95, 100, and 105—have prepaid faster than generic pools of the same vintage (Exhibit 1). The bulk of discount production was in 3.0% and 3.5% pools issued in 2012 and 2013; primary mortgage rates had reached some of their lowest levels of the last 20 years, and production declined substantially after 2013.
Exhibit 1: Prepayment speeds, January 2017 through July 2018
Source: Fannie Mae, Freddie Mac eMBS, 1010data, Amherst Pierpont Securities
On average, 2012 MHA pools are prepaying roughly 1.0 CPR faster than generic pools, while the 2013 MHA pools are generally 0.5–1.0 CPR faster than generic. While the 2013 MHA pools prepay slightly closer to generic than the 2012 pools, the gap should widen over the next year as the 2013 pools season and LTVs drop even lower.
Home price appreciation removes a barrier to moving
Many of these mortgages have mark-to-market LTVs less than 80% during 2017 and 2018, which has removed a barrier to prepaying the loan. Even the highest LTV loans had dropped below 80% LTV prior to 2017 (Exhibit 2). This likely unlocked the ability of these borrowers to move more easily—for example, a borrower can re-lever to 80% LTV and buy a larger home—and the possibility that housing turnover would match or exceed the levels of generic pools.
Exhibit 2: Date each cohort dropped below 80 LTV
Source: Fannie Mae, Freddie Mac, eMBS, CaseShiller, 1010data, Amherst Pierpont Securities
The 2013 vintage MHA pools are prepaying closer to generic pools than the 2012 vintage since they have less seasoning and accumulated HPA. This is particularly true of the 3.5%s 2013, which were originated later in 2013. However, over the next year the differential should widen to the 1.0 CPR exhibited by the 2012 vintage due to further home price appreciation.
MHA pools are less sensitive to cash out refinance rates
MHA pools should outperform generic pools if mortgage rates move higher, since discount MHA prepayments are less levered to cash out refinance rates. MHA pools have higher LTVs than generic pools, so fewer borrowers can do a cash out refinance. As rates move higher, some borrowers should forgo a cashout refinance if it is not economic, but fewer borrowers should avoid moving for the same reason. This should slow generic pool speeds more than MHA speeds, and is an additional source of extension protection in MHA pools.
MHA looks undervalued
These loans currently trade at roughly 20/32s to 28/32s over TBA. Payups are somewhat higher for 2012s over 2013s, and for 3.5%s over 3.0%s. Payups are roughly 40% to 45% of theoretical value for 3.0%s and 50% to 55% for 3.5%s (Exhibit 3). The payup is calculated by running the MHA bonds at the same OAS as each coupon’s TBA; the MHA bonds are run by dialing Yield Book to achieve 1.0 CPR faster discount speeds than the respective cohort.
Exhibit 3: Payups come in below theoretical values (as of 8/15/2018)
Note: All market levels as of 8/15/18. Source: YieldBook, APS
The theoretical value assumes that MHA pools will prepay 1.0 CPR faster in a sell-off, but this gap might widen into higher rates. This means the theoretical values should probably be even higher. All four MHA bonds are shorter duration and better convexity than the respective TBA. Hedged with roughly 85% of the TBA, the trade is positive carry.
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