By the Numbers
Slow housing puts a brake on MBS prepayment speeds
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.
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.
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.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.