By the Numbers
Cash out refis lift servicers’ speeds in discount MBS
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.
Mortgage servicers have a strong influence on how quickly borrowers refinance when interest rates fall, but servicers may also influence prepayment speeds in bonds priced below par. Housing turnover, cash out refinances, and defaults all shape discount prepayment speeds. The servicer has the most control over cash out refinancing, and the data suggest that servicers with a strong cash out business also have faster-than-average discount speeds. Many borrowers have built equity in their homes over the last two years, and some lenders may be more successful at marketing cash out refinances to their borrowers. With roughly 60% of agency MBS trading below par and investors worried about extension protection, a focus on servicers stands to enhance returns.
Some servicers’ discount prepayment speeds have been faster than others over the last year (Exhibit 1). The first column of data shows for some of the largest servicers how much faster or slower its loans in discount MBS prepaid over the last two years. Pools trading below par and serviced by Quicken, for example, prepaid 30.3% faster than the average comparable pool serviced by someone else. This analysis controls for attributes such as loan age and loan size to avoid rewarding a servicer that just happens to service loans that would prepay faster on their own.
Exhibit 1. Servicers with a strong cash out business have faster prepayments in pools priced below par
Source: Fannie Mae, Freddie Mac, Amherst Pierpont Securities
The final two columns give a measure of each servicer’s cash out refinance volume and purchase volume. The raw volume is easy to get from agency MBS issuance data but cannot be directly compared across servicers with different-sized servicing portfolios. Therefore, each number is a ratio of volume to that servicer’s MSR portfolio balance. The cash out numbers are further adjusted to remove the expected portion that are “opportunistic” cash out—borrowers that only take cash out when rates are low. That business should shrink when rates increase, leaving only borrowers that are willing to extract equity even if their loans’ note rate increases. Both metrics are further adjusted to be zero for the average servicer.
The data shows that servicers with the fastest discount speeds also tend to have the largest relative cash out refinance activity (Exhibit 2). And the slowest servicers tend to have the lowest cash out activity. Quicken and loanDepot lead the pack with the fastest discount speeds and, other than Amerisave, have the largest cash out measurement. Amerisave is unusual because its servicing portfolio grew disproportionately throughout the pandemic, which skews the result.
Exhibit 2: More cash out volume, faster speeds in discount MBS
Source: Fannie Mae, Freddie Mac, Amherst Pierpont Securities
The purchase numbers are somewhat mixed. Quicken looks a little below average but loanDepot well above. U.S. Bank, one of the slower discount servicers, is close to neutral on the purchase measurement. It makes sense that lenders probably can do little to encourage their existing borrowers to buy a new home and therefore the recapture rate for borrowers buying homes is probably lower than for borrowers refinancing. That would lead to less correlation between a servicer’s purchase volume and its own discount prepayment speeds.
It is natural to question whether a servicer’s past prepayment behavior will continue, especially without an explanation how a servicer influences discount prepayment behavior. It appears that servicers like Quicken and loanDepot have faster discount prepayment speeds because they are more adept at originating cash out refis. Since many borrowers have built substantial equity in their homes over the last two years these lenders should have a large supply of borrowers to solicit for cash out refinances even if rates increase.
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