By the Numbers

Slow housing puts a brake on MBS prepayment speeds

| September 9, 2022

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.

The slowing housing market weighed on MBS prepayment speeds in August, keeping them close to unchanged. August had three more business days than July, implying speeds could increase around 15%. But Fannie Mae 30-year speeds increased only 1% and Freddie speeds increased only 2%. Prepayment speeds were roughly unchanged across the coupon stack, likely because housing turnover slowed enough to offset the additional business days. Net supply, however, remains healthy.

Most MBS are far enough out-of-the-money that interest rates have little influence on prepayment speeds, so day-count and housing turnover are the dominant reasons MBS prepayment speeds change each month. However, originators have been working through a backlog of refinance applications, which kept speeds faster than expected for a few months this year. That pipeline appears to have dried up in July and August, which likely explains why speeds slowed slightly for 3.0% and higher coupon FNCL MBS but increased slightly for FNCL 2.0%s and 2.5%s (Exhibit 1). Cohort-level prepayment data is available here.

Exhibit 1: August 2022 Agency Prepayment Speeds, % Change

Source: Fannie Mae, Freddie Mac, Amherst Pierpont Securities

Ginnie Mae speeds were relatively flat compared to July, like the conventional result. However, speeds dropped sharply in higher coupons, likely due to slowing buyouts in those coupons. It is often not profitable for servicers to buy delinquent Ginnie Mae loans out of MBS pools when interest rates move higher, since financing the buyout becomes more costly. Banks were especially aggressive about buying out delinquent loans when interest rates were low, but bank buyouts have dropped sharply over the last few months.

Looking ahead

Prepayment speeds could slow 5% to 10% in September from a combination of lower day count and slowing turnover seasonal factors. Lagged mortgage rates are lower, which might provide a small lift to speeds in certain cohorts, but most pools are deep enough out-of-the-money that there is little sensitivity interest rates. Additionally, housing turnover continues to slow as higher mortgage rates, high home price appreciation, and concerns about the economy have pushed some prospective homebuyers onto the sideline. So turnover might slow more than what is predicted from typical seasonal factors.

Net Supply

MBS net supply fell roughly 9% in August but stayed about $40 billion for the fourth consecutive month. These levels are consistent with the slowdown in home sales from the torrid pace in 2020 and 2021. Average loan sizes are much higher than two years ago, which is keeping net supply well above pre-pandemic levels. Conventional issuance has swung heavily towards Freddie Mac this year, and the difference was pronounced in August. Fannie supply fell from July to August and its net issuance dropped to roughly $4 billion in August from $12 billion in July. But Freddie issuance jumped to nearly $20 billion in August from roughly $14.5 billion in July.

Brian Landy, CFA
brian.landy@santander.us
1 (646) 776-7795

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