Uncategorized
Scanning for convexity in prime jumbo
admin | October 9, 2020
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.
Prepayment speeds in prime jumbo show no sign of slowing down. And traditional sources of convexity such as seasoning and loan size have offered little to no protection with prepayments on more seasoned trusts and loans with lower balances actually coming in faster than others. Safe harbor may be in more nuanced stories such as higher LTVs loans or increased concentration to particular servicers.
Finding prepayment protection in the prime jumbo market has become increasingly challenging as sustained low rates have continued to drive speeds faster. The issue is compounded by elevated speeds in loans that investors may assume should afford them some refuge from faster prepayments. Jumbo conforming loans are prepaying faster than those with non-conforming balances. And seasoned trusts are exhibiting faster speeds than more recent vintages, partially driven by greater concentrations of lower balance loans (Exhibit 1).
Exhibit 1: Seasoning offers little prepayment protection in prime jumbo
Source: Amherst Insight Labs, APS
Conforming jumbo borrowers in private label trusts with 100 bp of refinancing incentive have prepaid 10 CRR faster than their non-conforming jumbo counterparts at 53 CRR and 43 CRR, respectively, and exhibit steeper S-curves than both traditional conforming balance loans and non-conforming ones. Elevated speeds on jumbo conforming collateral are likely driven by both the decoupling between conforming and non-conforming rates and the generally lower friction to refinancing associated with agency-eligible loans. It appears both these drivers may persist for the foreseeable future and speeds on jumbo conforming loans will likely remain elevated as a result.
Elevated jumbo conforming speeds appear, in some part, to be driving faster speeds in seasoned collateral. As jumbo loans in seasoned trusts have paid down through amortization and curtailment, the population of jumbo conforming loans in these trusts is much larger than those of newer vintage deals. As of September, the 2017 vintage has the largest population of loans with balances between $400,000 and $600,000, making up 42% of all loans in the cohort. By comparison, loans with those balances make up just 25% of the 2019 and 2020 vintages. Conforming jumbo loans from 2017 prepaid at 58 CRR last month while similar loans in the 2018 vintage paid 61 CRR. By comparison, loans with balances greater than $1 million prepaid at 35 CRR and 30 CRR in the respective cohorts (Exhibit 2).
Exhibit 2: Jumbo conforming speeds remain elevated across vintages
Source: Amherst Insight Labs, APS
Finding protection in LTV and servicer stories
Given the lack of prepayment protection afforded by loan balance and seasoning, investors may have to look to more nuanced stories to find some protection from continued elevated prepayments. One potential source of protection is higher LTV loans which exhibit significantly flatter S-curves than those of lower LTV ones. Given the higher risk-based pricing associated with higher LTV loans, that incremental spread is captured and controlled for when evaluating sensitivity to different amounts of refinancing incentive. After controlling for this spread or, SATO adjustment, it appears that given the same amount of refinancing incentive, high LTV loans prepay much slower than lower LTV loans. At 50 bp of refinancing incentive, loans with original combined LTVs of 90 or greater prepay at roughly 5 CRR while loans with lower LTVs prepay at 35 CRR or faster. (Exhibit 3) As the incentive goes further in the money the relationship is roughly similar as the high LTV cohort prepays at roughly 17 CRR given 100 bp of incentive while 70-80 LTV loans prepay at roughly 50 CRR.
Exhibit 3: High LTV loans exhibit flat S-curves
Source: Amherst Insight Labs, APS
It seems plausible that dampened prepayments may be due to higher LTV borrowers having fewer channels to refinance their loans relative to lower LTV ones and may be a material friction to refinancing. Additionally, while SATO has been controlled for, there may be other attributes to higher LTV loans that may drive slower speeds as the analysis does not control for other attributes. However, after controlling for loan size, it appears that high LTV loans still offer significant prepay protection versus lower ones in both jumbo conforming and non-conforming cohorts.
Certain prime servicers have also exhibited flatter S-curves than others. Conduit transactions will have multiple seller/servicers, and as a result, gaining isolated exposure to slower servicers may be somewhat challenging. But investors can add convexity by adding exposure through pools with larger proportions of slower servicers. One major prime servicer that stands out is First Republic. After controlling for SATO and looking solely at fixed-rate originations, First Republic originated and serviced loans prepay at roughly half the speed of some other major prime seller servicers given 50 bp of refinancing incentive. At 50 bp of incentive loans serviced by both First Republic and Wells Fargo have prepaid at an average rate of 22 CRR. However, as the option goes deeper in-the-money, speeds on First Republic serviced loans remain relatively muted at 35 CRR while, Wells Fargo serviced loans have prepaid upwards of 57 CRR given 100 bp of refinancing incentive (Exhibit 4).
Exhibit 4: Prepayment S-curves by seller/servicer
Source: Amherst Insight Labs, APS
Breaking the analysis into jumbo conforming and non-conforming buckets, jumbo conforming loans serviced by First Republic have prepaid at just over 17 CRR given 100 bp of incentive while loans with comparable incentive serviced by United Shore have prepaid upwards of 53 CRR and those serviced by Loan Depot have prepaid at 58 CRR. Looking at non-conforming balances, First Republic still maintains slower in-the-money speeds, albeit more modestly, than all other servicers as loans with 100 bp of incentive have prepaid at roughly 35 CRR. Those serviced by JP Morgan Chase with similar incentive have prepaid at 45 CRR, while those serviced by Flagstar have prepaid upwards of 50 CRR.
Thoughts on relative value
Investors can get relatively concentrated exposure to the convexity afforded by high LTV collateral as certain shelves like JPMMT issue deals backed solely by high LTV loans. However these deals are not backed solely by loans with greater than 90 LTV ratios and, as a result, in-the-money speeds should be somewhat suppressed by the population of those loans but still somewhat elevated given the material concentration of loans with LTVs greater than 75 but less than 90 in these pools. Despite the improved convexity of higher LTV loans, pass-throughs backed by this collateral actually trade behind generic jumbo pass throughs. 3.0% LTV pass throughs currently trade at $1-28 back of UMBS 3.0%, a roughly 4/32 concession to generic 3.0% pass throughs. Admittedly, some of the convexity associated with the collateral is mitigated to some extent by the structure as LTV pass throughs often have double the amount of credit enhancement as their generic counterparts making the LTV pass through more sequential-like given the shifting interest structure. Even with the greater structural leverage, it appears that the convexity associated with higher LTV collateral should trade at premium not a concession to more negatively convex generic bonds.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.
