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Prepayment speeds take off in July

admin | August 9, 2019

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.

Fannie Mae and Freddie Mac 30-year prepayment speeds jumped in July, rising slightly faster than expectations of a 25% to 30% month-over-month increase. Fannie 30-year speeds rose 31% and Freddie speeds 33% overall. Fannie Mae and Freddie Mac 30-year 4.0%s skyrocketed 50% and 54% respectively. This was driven by fast prints in the 2018 and 2019 vintages, which jumped more than 80% and in many cases prepaid faster than the same vintage 4.5%s.

Exhibit 1: July speeds surged in response to the May rate rally

Note: % change in 30-year prepayment speeds from June 2019 to July 2019. Source: Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

The market anticipated faster speeds after rates dropped in May, the bulk of which occurred late in the month with a limited effect on June speeds. Two additional business days in July contributed to faster speeds, and seasonal turnover remains strong. The agencies reported July speeds on August 7.

The prepayment danger zone

Loans in the 6- to 12-WALA range are the most refinanceable since much of the loan documentation is still fresh and the old appraisal often valid. This is why the 2018 vintage likely prepaid so quickly. Many lenders attempt to limit prepayments within the first six months, and after 12 months documentation becomes stale. There is a pay-up for low WALA pools because speeds are so slow for the first few months, but an investor could lose out if rates drop while the pool is in the 6- to 12-WALA danger zone.

Ginnie Mae speeds also jumped higher. Ginnie IIs in particular increased 25% overall with strong increases across 3.0%s through 5.5%s. This was a little slower than in conventionals, but Ginnies were already prepaying much faster. The absolute prepayment pickup was actually greater than conventionals. Higher coupons slowed, most likely due to a drop in buyouts.

More than half the market is refinanceable

Interest rates have fallen sharply over the last few days. The 10-year Treasury rate fell to 1.63% as of Wednesday morning from 2.06% six days earlier. This move has pushed the share of outstanding conventional 30-year mortgages in-the-money to 54%. The percent in-the-money is determined using the spread between a loan’s note rate and the current Freddie Mac Primary Mortgage Market Survey rate. A loan is considered in-the-money if the spread is at least 75 bp.

Projected aggregate MBS prepayment speeds should rise from here (Exhibit 2) The current rally should primarily affect September speeds (October report), when aggregate speeds should reach 19 to 20 CPR, which is 20% to 25% faster than July. Turnover begins to slow in September and day count is low—2 fewer business days than in July and August—which somewhat tempers the pick-up due to lower rates.

Exhibit 2: 54% of MBS are in-the-money at current rates

Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities

For prepayment speeds to reach the level seen in late 2012 and early 2013, the 10-year Treasury rate would need to drop to roughly 1.0%. The mortgage market should be roughly 80% in-the-money, the Freddie survey rate should be about 2.70%, and the MBS current coupon would be 2.0%s. Prepayment speeds would reach roughly 30 CPR at those rates.

The last time the market was this refinanceable was in mid-2016

Exhibit 3 plots aggregate prepayment speeds each month since January 2009. The percent of the market that is in-the-money is printed inside each bubble. The last time the market was over 50% in-the-money was in mid-2016 (post-Brexit) and speeds reached a little over 20 CPR.

Exhibit 3: Historical CPR and % in-the-money over time

Note: % > 75 bp ITM printed at each data point; 53.9% ITM as of 8/7/2019. Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities

July speeds look pretty strong compared to prior times that the market was 28% in-the-money, but a few factors explain this:

• July is in the middle of the summer and housing turnover is at its peak.
• Newer loans can respond to lower rates more quickly, so a 45-day lag likely understates how many of those loans are in the money (rates fell rapidly in late May so there is a relatively large difference between a 30 and 45 day lag).
• There is less burnout in the market.