The start of a rough plateau and slowdown in speeds
admin | December 11, 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.
MBS portfolios swimming in prepaid principal finally got some relief in November when speeds slowed for the first time since July, the likely start of a rough plateau and eventual broad decline. Fannie Mae and Freddie Mac 30-year speeds each slowed roughly 13%, more than the consensus expectation of a 5% drop. Ginnie Mae II speeds slowed 2%. Seasonally slower speeds through most of the winter and originators’ narrowing ability to drop rates further should keep total prepayments running flat to lower, good news for investors holding MBS at premium prices.
Fewer business days, seasonally slower turnover and the Thanksgiving holiday all contributed to the November drop in conventional prepayments. The MBS refinance index had increased slightly heading into November, and the resulting pickup in refinancing was expected to reduce the slowdown. Originators were also working hard to close loans in November, before the GSEs’ new adverse market refinance fee became effective on December 1.
Ginnie Mae prepayment speeds also slowed, although by only 2% in the larger Ginnie Mae II program. Non-bank buyout rates were relatively tame for yet another month, although a pickup in buyouts by Lakeview contributed prepayments that kept Ginnie II speeds from falling as much as conventional MBS prepayments.
Prepayment speeds should rebound slightly in December, which adds an additional 1.5 business days. Expect 30-year MBS to increase roughly 5%. However, the November data continues to indicate that MBS prepayment speeds have likely plateaued. The refinance index has failed to break much beyond the 4,000 level since the initial massive jump in March (Exhibit 1). Although the index slowly increased over the course of September and October, it leveled off in November. Expect a sharp seasonal slowdown in January and February, and speeds should run broadly slower in 2021 as burnout takes hold.
Exhibit 1: The refinance index reached a plateau in November
Refinance applications leveled off in November even though mortgage rates continued their decline (Exhibit 2). This indicates that the origination volumes are mostly constrained by capacity, and originators lower rates just enough to keep their pipelines filled. There has been hiring, so capacity probably has increased, but not enough to push speeds sharply faster.
Exhibit 2: The MBA refinance index stayed below 4,000 while mortgage rates fell in November
Lower rates compressed the primary/secondary spread further, to roughly 135 bp. The primary rate has been artificially high compared to pre-pandemic levels, which means the spread has also been too high (Exhibit 3). There would be no effect on prepayment speeds if the primary rate fell 20 bp to 25 bp without any effect on the average rate borrowers receive. In fact the relationship moved roughly 5 bp closer to normal in November.
Exhibit 3: The relationship between originations and the survey rate is stil skewed
Ginnie Mae buyouts remain tame in November, with one exception
Another month passed without a significant buyout event in Ginnie Mae pools. Most large non-bank servicers bought out very few delinquent loans, with a handful of exceptions. The most notable is Lakeview, which bought out 10% of their delinquent loans in October and bought out 15% in November. Carrington and PennyMac also continued to buyout more delinquent loans than most non-banks, but the pace slowed slightly (Exhibit 4).
There was little change in behavior among the bank servicers, although the overall effect on prepayment speeds continued to diminish since there are fewer delinquent loans remaining in pools. However, a couple of banks—MidFirst and Flagstar—have not been consistently buying out delinquent loans and therefore have higher delinquency rates than most of the other banks. Their pools pose a greater risk since they should be able to easily finance more buyouts at any time.
Exhibit 4: Lakeview increased their buyouts in November
The Fannie Mae and Freddie Mac numbers
Conventional 30-year prepayment speeds fell close to 13% at both Fannie Mae and Freddie Mac (Exhibit 5). The slowdowns were consistent across much of the stack, although Freddie pools slowed slightly more in 2.0%s and 2.5%s. Speeds slowed across vintages, although not as much in 2020 production. Almost all the 2020 pools issued in January through April slowed. These pools had been prepaying the fastest in the 2020 vintage. However, speeds picked up in May 2020 and newer issuance. For example, FNCL 2.5%s issued in April 2020 slowed to 36.9 CPR from 39.0 CPR, while pools issued in May jumped to 29.2 CPR from 22.9 CPR.
Exhibit 5: November prepayment speeds slow for the first time since July
Exhibit 6: Prepayment Summary
Our short term forecast is shown in Exhibit 9 (Fannie Mae) and Exhibit 10 (Freddie Mac). Exhibit 8 shows the static rates used in the prepayment forecast.
Exhibit 7: Agency Speeds, Largest Cohorts
Exhibit 8: Mortgage Rate Forecast
Exhibit 9: Fannie Mae Short Term Forecast
Exhibit 10: Freddie Mac Short Term Forecast