By the Numbers
Tightening commitment rates should keep GNPL speeds going
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.
Prepayments in Ginnie Mae project loans fell moderately in March across most vintages after surging through 2020 and into the first part of this year. But speeds are still above their historical pace based on current refinancing incentives. The spread between project loan commitment rates and 10-year Treasury rates, which had lingered wide for months during the depths of the pandemic, fully normalized in March and shows early signs of tightening in April. One likely consequence for investors is that prepayments will remain elevated as long as Treasuries continue to range trade, a benefit to IO holders getting the prepayment penalties.
Across most vintages, March prepayment speeds fell back to levels last seen in September or October of 2020 (Exhibit 1). During that time Treasury rates were range trading from 60 bp to 80 bp, but the spread between project loan commitment rates and Treasury rates was 200 bp to 225 bp, keeping average project loan rates stuck between 2.65% to 2.90%.
Exhibit 1: Ginnie Mae project loan prepayment speeds
Note: Data as of April 2021.
Source: Intex, Amherst Pierpont Securities
The exception to slower March speeds remains the 2016 vintage, where speeds continue to hover near the peak. Most 2016 vintage loans have prepayment penalties in the 4-point to 6-point range and have several years of price appreciation behind them, increasing the incentive for cashout refinances or sales. Speeds in this penalty cohort (Exhibit 2, green line) were the fastest in the early months of the pandemic and have yet to materially moderate.
Exhibit 2: Voluntary prepayments by penalty amount
Note: Ginnie Mae project loans 3-month CRR, post-lockout. Data as of April 2021.
Source: Intex, Amherst Pierpont Securities
Project loan commitment (PLC) rates ticked a few basis points higher during the first quarter of this year while Treasury rates rose 60 bp, compressing the spread between the two. However, that spread widened significantly during the pandemic (Exhibit 3), so the recent tightening has represented a return to normalcy. During March, PLC rates averaged 2.53% and the 10-year Treasury at the time of commitment averaged 1.25% (most of the March production pools were originated in February). The 128 bp spread in March is in-line with the 127 bp average spread between PLC and Treasury rates during the four years before to the pandemic.
Exhibit 3: PLC rates vs 10-year Treasury and current coupon MBS rates
Note: Data as of April 2021.
Source: Intex, Amherst Pierpont Securities
Project loan commitment rates for new origination averaged 2.53% in March and have risen to 2.66% in April based on relatively small amount of production known so far. May rates look to be running in the same range, which remains low relative to levels over the past five years. Although prepayment speeds have moderated in March, the compression in the spread could keep rates low and speeds elevated if Treasuries stay comfortable in the current range.
If speeds were to migrate back towards normal historical levels (Exhibit 4, gray line on s-curve chart), they would drop to between 10 CPR and 30 CPR assuming refinance incentives of 100 bp to 200 bp.
Exhibit 4: S-Curve by rate incentive (CRR, post-lockout)
Note: The refinance incentive includes an adjustment for the penalty points due on the loan. The equivalent rate incentive required to offset the penalty points is equal to the penalty points divided by the IO multiple. For a recent production IO the multiple is assumed to be 10. So a loan with 5 penalty points requires a 50 bp rate drop to offset the premium, and a loan with 10 penalty points requires a 100 bp rally in PLC rates to offset the premium. If you assume both loans have 3.50% coupons and PLC rates are now 2.50%, the loan with 5 penalty points has a 50 bp refinance incentive while the loan with 10 penalty points would be indifferent to refinance, or have a zero incentive. Data as of April 2021.
Source: Intex, Amherst Pierpont Securities
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