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Little prepayment surge likely in wake of Hurricane Florence

| September 14, 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.

Relatively low exposure to areas most likely to get hit by Hurricane Florence should protect most agency MBS investors from significant changes in prepayments.

Hurricane Florence came ashore in North Carolina on Friday as a Category 1 storm with 90 mph sustained winds. High population areas inland from the North and South Carolina cost may be affected if Florence stalls over land until Sunday and causes catastrophic flooding. Hurricane warnings have been issued along the coastline as far south as Hilton Head Island, South Carolina, and as far north as Virginia, expanding the potential scope of affected areas.

The agency MBS market has only a small number of pools concentrated in these states. For example, 90% of outstanding pools have less than:

  • 5% exposure to North Carolina
  • 1% exposure to South Carolina
  • 8% exposure to Virginia

Few investors look likely to own a pool or bond with a large exposure to these states. North Carolina loans are currently 2.8% of outstanding balance and Virginia is 3.6%, so both are on the larger size, but South Carolina is only 1.3%.

Moreover, the large population centers in all three states tend to be inland. The most severe force of the storm and the most severe flood risk look likely to affect less populated areas. Only a fraction of the mortgages in these states should face the largest risk of damage or  of borrowers facing job loss or other hardships due to the storm. It is unlikely that an investor’s exposure to these states is concentrated in coastal areas.

Finally, many loans that initially default will likely be given time to recover, helping to protect investors from an immediate spike in prepayments. Fannie Mae, Freddie Mac, Ginnie Mae, and the government agencies (FHA/VA/USDA/PIH) have various tools at their disposal to assist borrowers affected by a natural disaster. Fannie Mae and Freddie Mac can, and likely will, permit loans to remain in pools after the typical 120-day delinquency buyout trigger. The experience of hurricane Maria on Puerto Rico pools shows that recovery rates can be very high.

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