By the Numbers
CRT cure rates continue to improve
Chris Helwig | December 10, 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.
Delinquency rates in Fannie Mae and Freddie Mac credit risk transfers continue to fall at a rapid pace as forbearance plans come to term. More than 80% of loans referenced in GSE CRT that were seriously delinquent last summer have subsequently re-performed or prepaid. The rise in cure rates should help drive CRT spreads tighter based on both fundamental credit performance and growing amounts of principal returning to investors for potential reinvestment in newly issued CRT transactions.
Breaking down performance
Through September, 81.1% of loans referenced in Fannie Mae CAS deals that were seriously delinquent last summer have subsequently cured or prepaid—roughly 15% improvement over the past six months. Cure rates for a comparable population of loans referenced in Freddie Mac STACR deals totaled 83.2% through September and more than 86.1% through October—reporting lags in Freddie Mac deals are one month shorter than those in Fannie Mae transactions.
Elevated cure rates appear to be primarily driven by a combination of borrowers’ ability to defer arrearages incurred during forbearance to the maturity of the loan in non-accrual status coupled with their ability to prepay. The incidence of deferrals in previously seriously delinquent Fannie Mae reference loans were just over 37% with an additional 7.5% of borrowers self-curing. Freddie Mac’s reporting does not distinguish between deferrals and self-cures, but they combined to account for 46.9% of delinquent loans that have re-performed through October (Exhibit 1).
Away from payment deferrals, prepayments were the next largest driver of cures across delinquent loans in both Fannie Mae and Freddie Mac CRT. More than 32% of delinquencies referenced in Fannie Mae CAS transactions cured through prepayment while over 34% of the population of delinquent loans analyzed in Freddie Mac deals prepaid. Prepayment speeds on loans previously in forbearance have likely surprised to the upside. Observations earlier this year would have suggested that prepayment rates on loans coming out of forbearance could have been in the range of 20 CPR. Empirical speeds have been nearly 50% faster than previous estimates.
Conversely, reperformance through modification is rising to some extent but is still relatively muted. The incidence of modifications on Fannie Mae reference loans totaled 3.3% in September up roughly 2% since the beginning of the year. Loan modifications accounted for 2.9% of cures in Freddie Mac reference loans through October, an increase of roughly 180 bp since the beginning of the year.
Exhibit 1: Breaking down re-performance across delinquent loans in Fannie Mae CRT
Breaking down cures by borrower attributes
As upwards of 80% of previous serious delinquencies have cured there is likely some expectation that the remaining population of delinquent borrowers may be becoming increasingly adversely selected. However, cure rates, while not uniform, are generally elevated across most borrower attributes. The most pronounced differences were evident across borrowers’ credit scores with modestly lower cure rates across lower FICO borrowers. Lower FICO borrowers underperformed the broader average, but not by much. Those with FICO scores less than 640 have cured at a rate of 72% while borrowers with scores between 640 and 680 have cured at a rate of 75% both exhibiting a roughly 15% increase in cure rates over six months. High FICO borrowers, with credit scores of 760 or greater have cured at a rate of 85%. Differences in cure rates across borrowers’ LTV ratios were even more muted. Borrowers with current LTVs of 90 or more have cured at a rate of 77% compared to borrowers with LTVs less than 60 who have cured at 82%.
Delinquency rates start to dip on a percentage basis, finally
Despite the steady rise in cure rates over the past year, investors in CRT have been subject to protracted cash flow lockouts as prepayments outstripped cure rates, keeping the percentage of delinquent loans in reference pools elevated which in turn caused delinquency triggers in the deals to continue to fail despite the improvement in credit performance. As cure rates eclipse 80% and prepayments of reference pools have slowed, there is finally signs that improving fundamentals will lead to an increase in principal cash flow being returned to investors. Using the Fannie Mae 2018 vintage as an example, delinquencies on loans in forbearance plans peaked in June of last year at 7.6%. The delinquency percentage on the cohort was as high as 7.2% in February and has dropped dramatically to 4.0% as of September. (Exhibit 2)
Exhibit 2: Forbearance loans start to fall on a percentage basis
Elevated cure rates and growing amounts of principal being returned to investors should provide a tailwind to spread tightening in CRT next year. As forbearance plans come to term through the remainder of this year, paydowns from existing deals should increase. Looking at 2019 performance against the backdrop of low delinquencies and higher interest rates, annual paydowns totaled slightly less than $11 billion on average bond balance of $58.2 billion. Comparable paydowns would offset 18% of gross issuance next year assuming those proceeds were reinvested in CRT would equate to between $32 and $38 billion of net issuance next year with an additional $7 to $10 billion adjustment for incremental catch-up Fannie Mae issuance. Net supply of $43 to $49 billion meted out over the entire year should meet with reasonable demand although placing larger deep subordinate classes may continue to be challenging given the finite investor base and limited amount of paydowns to be repatriated into newer deals potentially suggesting a steepening of the credit curve as more cash is returned to mezzanine bond holders.