Poised for slower prepayments
admin | January 8, 2021
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.
After a small rise in prepayments in December, MBS speeds should begin to drop in January and beyond. The recent downdraft in MBS prices should push mortgage rates higher and speeds slower, especially since lenders have little room to narrow the spread between primary and secondary mortgage rates. As interest in extension protection begins to build in the next few months, interest in low loan balance pools and low FICO pools may pick up.
A bump higher in December
Conventional 30-year prepayment speeds increased in December, mostly driven by an increase in business days. Overall origination activity remains capped by capacity constraints, limiting the potential increase in refinancing activity. Fannie Mae speeds increased 7% and Freddie Mac speeds increased 5%, in line with Amherst Pierpont expectation of a 5% pickup. Street consensus looked for a 10% to 15% jump, likely assuming a continuing decline in primary rates would translate into faster speeds. But the average production rate has not fallen as much as primary rate surveys like Freddie Mac’s, which can lead to overestimates of prepayment speeds.
Prepayment speeds should fall 10 to 15% in January, typically a very slow month for prepayments. Housing turnover falls to its seasonal low and January has 1.5 fewer business days than December. The refinance index was relatively stable in December, continuing a trend from the prior few months, so refinancing activity is unlikely to increase (Exhibit 1). However, the government index spiked in early December, signaling that Ginnie Mae speeds may not drop as much as conventional in January. Beyond January, prepayment speeds could start to slow if the sell-off holds and mortgage rates shift higher.
Exhibit 1: The refi index holds steady, although shows a jump in government activity in early December
The Freddie Mac Primary Mortgage Market Survey rate continued to drift lower in December. However, as has been the case for the last few months, the drop had little effect on refinance activity since originators are operating near capacity. They only have an incentive to lower rates just enough to keep their pipelines filled.
Exhibit 2: The primary rate continued to fall with little effect on refinance activity
Furthermore, over the last few months the rate borrowers receive has not dropped as much as Freddie’s survey rate. For example, the lagged month-average survey rate fell 22 bp from September to December, but the average origination rate only dropped 8 bp over that same period. Throughout much of the pandemic, the survey rate was overstating the rate borrowers received. This caused models and forecasters to underpredict prepayment speeds, especially early in the pandemic as the relationship diverged. Now the opposite is occurring as the relationship adjusts back to normal. The survey rate falls, making it appear as if speeds should increase. But borrowers have not received those lower rates, so speeds come in slower than forecasts.
Exhibit 3: The survey rate has overstated the drop in mortgage rates over the last three months
Lakeview continues to expand Ginnie Mae buyouts
Lakeview increased their buyouts for the second straight month. They bought out 22.1% of their loans that are at least 60 days delinquent in December, an increase from 12.2% in November. But buyouts remained steady at most other servicers, whether bank or non-bank. For example, PennyMac bought out 8.1% of their D60+ loans in December and 8.0% in November. Freedom’s buyout pace remained extremely low at only 1.3% of D60+ loans.
Among the banks, many have few loans remaining to buyout, so the effect on speeds is relatively low. However, Flagstar has not been aggressively buying out loans and now has 16% of their loans at least 60 days delinquent. Pools with a heavy Flagstar concentration could prepay extremely quickly should they ramp up their buyouts.
Exhibit 4: Lakeview further increased buyouts in December
The Fannie and Freddie numbers
Fannie Mae 30-year MBS increased 7.3% and Freddie Mac increased 5% in December, driven by an additional 1.5 business days. The increase was in-line with our expectation was for a 5% increase, with slower turnover moderating the effect of day count. Most 2019 and earlier vintage cohorts increased consistent with day count. Some lower coupon pools, mostly 2020 production, jumped more. That’s because these loans are the ones sensitive to the small drop in interest rates and are ramping into the peak refinancing window.
Exhibit 5: Day count pushed speeds faster in December
The recent MBS sell-off should push mortgage rates higher, raising the prospect of slowing prepayment speeds. Low loan balance specified pools have historically prepaid faster when out-of-the-money, providing a good source of extension protection. These borrowers are often in starter homes and more likely to need to move into a larger place as their families grow. Low FICO pools are another possibility—some borrowers will see their credit improve and choose to move into a nicer home, and borrowers that remain low credit are more likely to default.
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