Rising prepayment speeds ahead
admin | September 13, 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.
MBS prepayments rose in August in a precursor to faster prints in September and beyond. Sharply lower interest rates should keep driving speeds up into the fall. Even with 10-year yields up nearly 40 bp since the start of this month, primary mortgage rates have only moved up 4 bp. Newer Fannie Mae and Freddie Mac pools have started to show some speed differences, with Freddie Mac speeds leading the way. And Ginnie Mae’s highest coupons have jumped well ahead of their conventional counterparts. MBS investors have plenty of prepayment volatility ahead.
Learning from recent history
Fannie Mae 30-year speeds increased 6.5% to 17.4 CPR from 16.4 CPR and Freddie Mac 30-year speeds increased 7.1% to 17.8 CPR from 16.8 CPR, both in-line with expectations (Exhibit 1). Overall Ginnie Mae speeds also met expectations, with Ginnie I speeds up 3.9% to 15.4 CPR from 14.9 CPR and Ginnie II speeds jumping 7.8% to 22.5 CPR from 21.1 CPR.
Exhibit 1: August prepayment speeds edged faster
The Fannie Mae and Freddie Mac numbers
In aggregate the two GSEs’ speeds increased by comparable amounts, so overall Freddie speeds remained a bit faster than Fannie speeds. The difference is largest on newer cohorts; 2017, 2018, and 2019 vintage Freddie cohorts generally prepay faster. For example one of the largest differences came in the 4.0%s of 2019; the Freddie cohort increased 13.3% and reached 28.8 CPR, while the Fannie cohort was almost unchanged at 24.9 CPR.
Ginnie Mae super-premiums jump more than conventionals
Overall Ginnie Mae speeds moved similarly to conventionals, but higher coupon Ginnie IIs picked up quite a bit more. For example, overall G2 4.5%s jumped 17.8% while Fannie 4.5%s increased only 7.6%. This is coming form 2019 vintage pools that have been prepaying very slowly but are suddenly jumping past conventionals. For example, Ginnie II 4.5%s 2019 printed 9.8 CPR in July and 21.0 CPR in August, while Fannie 4.5%s printed 24.7 CPR in July and 24.9 CPR in August.
The surge reflects FHA and VA both enforcing seasoning requirements on refinances. The FHA requires six months seasoning on the original loan before it can use the streamlined refinance program. The VA requires seven months for any refinance. The government agencies can enforce this requirement regardless of the lender used to do the refinance.
Most conventional lenders have a similar policy, but it is much harder to enforce when a borrower changes lenders or uses a broker or correspondent lender. A lender’s retail employees must abide by any seasoning requirement, but a third-party originator, like a broker, could easily refinance a loan with a different lender. It would be up to various lenders to monitor the behavior of their broker and correspondent partners in order to control adverse behavior.
Lower coupons aren’t experiencing this yet since those loans are newer. But as the 2019 3.0%s and 3.5%s season they will likely begin to prepay much faster than those conventional cohorts. Therefore investors should be cautious about 2019 vintage Ginnie pools that might be prepaying really slowly but are on the verge of spiking much faster.
August’s sharply lower interest rates should spur heavy refinancing in September and October. September is a short month with two fewer business days, however, and typically marks the start of the fall seasonal slowdown. The shorter month and seasonal slowdown should mute refinancing, with overall speeds rising only 0% to 5% over August. But the aggregate increase doesn’t tell the whole picture—newer 30-year 3.0%s and 3.5%s should prepay a fair bit faster.
Speeds in October (November report) should increase another 10% to 15% over September since there are 2.5 additional business days. Refinancing should increase in some of the more seasoned vintages with longer timelines from rate lock to closing.
Slightly more than half the market is refinanceable
Slightly more than half the MBS market is in-the-money to refinance, meaning it has at least 75 bp of rate incentive. While this proportion sounds like a lot, prepayment speeds should remain well below the peak speeds seen in late 2012 and early 2013. Projected aggregate prepayment speeds across a range of interest rate scenarios shows roughly 19 CPR when the 10-year Treasury rate is at 1.55% and primary rates are just under 3.50% (Exhibit 2). These speeds would be consistent with the refi waves of early-2015 and mid-2016. In order to reach the speeds seen in 2012 (roughly 30 CPR) the 10-year Treasury rate would need to fall to about 1.0%.
Exhibit 2: More than half of MBS are in-the-money at current rates
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 MBA refinance index has matched 2016 levels but remains well below 2012
The MBA refinance index provides evidence that rates need to rally further in order for prepayments to reach 2012 levels and that the current refi environment is comparable to the 2015 and 2016 refi waves. The index recently peaked at 2,754.70 on August 16, which is comparable to the peak levels seen in early 2015 and mid-2016. Exhibit 3 shows that in both those periods the market was roughly 50% in-the-money and prepayment speeds were roughly 20 CPR. The percent refinanceable is shown by the numbers inside the circles and the prepayment speed is plotted on the left-hand axis. On October 12, 2012 the refi index reached 5,912.99 (roughly 115% higher than the recent peak), over 80% of loans were in-the-money and aggregate prepayment speeds topped 30 CPR.
Exhibit 3: Historical CPR and % in-the-money over time
Exhibit 4: Prepayment summary
Our short term forecast is shown in Exhibit 7 (Fannie Mae) and Exhibit 8 (Freddie Mac). Exhibit 6 shows the static rates used in the prepayment forecast.
Exhibit 5: Agency speeds, largest cohorts
Exhibit 6: Mortgage rate forecast
Exhibit 7: Fannie Mae short term forecast
Exhibit 8: Freddie Mac short term forecast