October marks the prepayment peak for 2019
admin | November 8, 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.
Prepayment speeds increased again in October, matching expectations of a 10% jump, but it’s likely downhill from here. A few additional business days and lower mortgage rates on a 45-day lag helped push seasoned loans faster last month. Seasoned loans typically take longer to close and respond at a longer lag to lower interest rates. The pace in government loans lagged conventionals, but continued elevated levels of the MBA Government Refinance Index suggests that Ginnie Mae speeds should beat conventionals in November. But the overall pace should fall.
Prepayment speeds should fall roughly 20% in November, which is typically a slow month. The major driver is that November has three fewer business days than October due to holidays; this implies a roughly 14% slowdown. An increase in lagged interest rates increase and seasonal factors continue to decline, further contributing to slower expected prepayment speeds.
High SATO loans continue to show call protection
Loans with high SATO, or spread at origination, demonstrated slower prepayment speeds than lower SATO loans in October (Exhibit 1), prepaying 5 CPR to 10 CPR, or 15% to 30%, slower when greater-than-75-bp in-the-money.
Exhibit 1: Higher SATO loans maintained a flatter S-Curve in October
Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities
Recent production pools tend to have a higher SATO for a given coupon than pools produced earlier in the year, since the loans locked interest rates at or near the recent rate lows. For example 3.5% pools issued in September and October averaged 64 bp SATO, while pools issued in February and March averaged 7 bp SATO. Higher SATO and lower gross WACs should give current production pools better convexity than pools issued earlier in 2019. A recent analysis suggests that high SATO, all else equal, could be worth 6/32s to 13/32s assuming such pools only prepay better from 6 WALA to 24 WALA.
The Fannie Mae and Freddie Mac numbers
Overall Fannie Mae 30-year speeds increased 11.1% to 21.2 CPR from 19.3 CPR and Freddie Mac 30-year speeds increased 8.9% to 21.7 CPR from 20.1 CPR, both in line with expectations. The slower pickup in Freddie Mac pools narrowed the overall speed gap to 0.5 CPR from 0.8 CPR. Although the improvement is small, it reverses a trend of faster prints in Freddie Mac pools and is likely a relief to regulators and Freddie Mac.
Exhibit 2: Conventional speeds jump in October
Source: Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities
Prepayment speeds posted the largest increases in 2017 and earlier vintages. These loans take longer to refinance, so the lag from rate lock to closing is longer than for newer loans. Therefore these cohorts’ prepayments were driven by the low rates in August, while many 2018 and 2019 vintage loans were able to close refinances at those rates in September.
Ginnie Mae speeds lagged slightly
Ginnie Mae I prepayment speeds increased 6.2% to 15.8 CPR from 14.9 CPR and Ginnie Mae II speeds increased 8.2% to 24.6 CPR from 23.0 CPR. These gains were slightly less than conventional increases. However the MBA refinance index has shown government mortgage application activity remained elevated in October while conventional applications fell. This suggests that Ginnie Mae speeds are poised to move faster than conventionals next month. Low WALA prepay protection is stronger for government loans than conventional loans, so much of the activity is likely to be government borrowers poised to reach 6 or 7 months of seasoning.
Exhibit 3: Prepayment Summary
Our short term forecast is shown in Exhibit 6 (Fannie Mae) and Exhibit 7 (Freddie Mac). Exhibit 5 shows the static rates used in the prepayment forecast.
Exhibit 4: Agency Speeds, Largest Cohorts
Exhibit 5: Mortgage Rate Forecast
Exhibit 6: Fannie Mae Short Term Forecast
Exhibit 7: Freddie Mac Short Term Forecast
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