By the Numbers
Muted impact of agency loan limits on jumbo PLS speeds
Chris Helwig | October 29, 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.
A likely 20% jump in Fannie Mae and Freddie Mac loan limits should lift prepayments in prime jumbo private-label MBS more from lower frictions in agency refinancing than from lower agency primary rates. Except for 2020, loans of similar size and type in agency and private-label MBS have prepaid in recent years at only marginally different rates. Shifting the agency loan limit up and capturing more loans now in private trusts should not change that.
Breaking down drivers of prepayments
The most pronounced driver of prepayment rates in prime private-label securitizations is loan size, and the effect of loan size on prepayment rates appears poised to rise next year as GSE loan limits may rise by close to 20% for both conforming and jumbo conforming loans. While the potential impact of new conforming limits will be felt by a large population of loans in private trusts, the subsequent impact on prepayment rates may be relatively muted. Last year, a near stop in the private-label market led to a substantial decoupling of prepayment rates between jumbo conforming and non-conforming loan. The frictions to refinancing non-conforming loans became far more pronounced, driving prepayment rates on conforming loans substantially higher than non-conforming ones given the same amount of refinancing incentive despite the incremental savings associated with refinancing the larger balance.
Assuming 50 bp of refinancing incentive, owner-occupied loans with balances greater than roughly $550,000 in agency pools prepaid roughly in-line with those in private-label trusts in 2019, with agency pools paying 4 CPR faster than those in private-label trusts. Last year that difference widened out to nearly 30 CPR and has subsequently normalized to the 4 CPR disparity observed in 2019 this year. The obvious caveat here is that while loan balances in GSE pools are capped at the jumbo conforming limit for these observations, the private-label ones are not, so despite potentially substantially higher loan balances in private-label trusts, the loans prepaid slower albeit in varying degrees across observation years (Exhibit 1).
Exhibit 1: Speeds between jumbo conforming and non-conforming have converged
The convergence in speeds this year may be in part be driven by the growing disparity between the average balance of jumbo conforming and non-conforming loans with comparable refinancing incentive. Looking at loans with 50 bp of refinancing incentive across the three observation years shows a steady increase in the difference between jumbo conforming and non-conforming balances which should in turn increase private label borrowers’ incentive to refinance their loans. In 2019, the difference between agency high balance and private label loans with 50 bps of refinancing incentive was just over $140,000. That difference grew to nearly $225,000 this year and may be a factor in the convergence between agency high balance and non-conforming speeds as larger savings in terms of nominal dollars given the same amount of refinancing incentive have likely spurred increased refinancing activity among non-conforming borrowers despite greater friction to refinancing higher balance loans. (Exhibit 2)
Exhibit 2: Higher PLS loan balances may be driving a convergence in speeds
Risk to faster speeds associated with conforming balance loans across the universe of PLS trusts is by no means uniform. It seems likely that originators will look to target newly conforming loans in private label trusts to be refinanced against the backdrop of higher conforming limits next year, assuming there is adequate rate incentive for those borrowers. Trusts backed by seasoned loans that amortized down below conforming limits saw a spike in prepayment rates last year as loans that could be refinanced into agency execution gained increased focus from originators in the absence of alternate private label channels.
Where available, county level zip code data was used to determine whether loans in private label trusts would fall under either conforming or agency high-cost limits assuming a 19% increase in those balances next year. Based on this methodology anywhere from 0% to nearly 40% of collateral backing certain private label trusts may be GSE eligible next year. (Exhibit 3)
Exhibit 3: Estimating the amount of newly conforming loans in PLS trusts
Deals with larger concentrations of newly conforming balance loans appear to be mostly concentrated in more recent vintages. This is likely a function of the fact that more seasoned trusts have already experienced significant refinancing activity on lower balance loans in the wake of the pandemic, leaving disproportionately larger amounts of higher balance, non-conforming loans. However, it is worth noting that many of these deals with higher concentrations of newly conforming loans were issued last year and this year against the backdrop of historically low interest rates and may have limited amounts of refinancing incentive despite larger stores of conforming loans.
Determining what the impact on prepayment rates from the increase in conforming balances is somewhat of a tricky exercise. An analysis of select private label transactions suggests that 3-moth prepayment rates may rise by 5 to 15 CPR for certain deals. The rise in prepayment rates would be mainly attributable to the fact the newly GSE eligible loans could be refinanced with PIW waivers in lieu of an appraisal. However, depressed prepayment rates observed across non-conforming loans last year may be distorting, and to some degree, overstating the value of PIW waivers as a contributor to faster conforming speeds. Ultimately, it appears rate incentive, or the lack there of, should trump agency eligibility in terms driving prepayments on loans in private label trusts going forward.
Prepayment highlights of October remittance reports
Some observations on this month’s prepayments across recently issued prime deals:
- Speeds on 2021 vintage deals across prime jumbo and prime investor were relatively muted
- More seasoned trusts whose loans are further up the WALA ramp showed elevated prepayments despite the presence of higher rates. However, this may be the tail end of a pipeline of refinances of these loans and speeds may subsequently slow if higher rates prevail
- Deals backed by higher WAC investor loans exhibited comparable prepayment rates to those backed by lower WAC collateral, likely a function of higher WAC deals having lower average loan sizes
- Benchmarking prepayment rates across agency eligible investor loans to comparable agency pools is somewhat challenging as agency pools with comparable WACs, loan sizes and seasoning tend to be low-loan-count and can exhibit relatively idiosyncratic prepayments