By the Numbers
Rising loan limits should lift specified pool pay-ups
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.
Spec pool pay-ups could get another lift in 2023 as the conforming loan limit will increase 12.2%. The higher limit should allow more high balance loans to be securitized in TBA-deliverable pools, raising the average loan size. Larger loans typically refinance more rapidly when mortgage rates are low and prepay more slowly when mortgage rates are high. This lowers the convexity and value of TBA contracts, increasing the premium over TBA that investors will pay for loan balance specified pools and other specified pool types with smaller-than-average balances.
The conforming loan limit is increasing to $726,200, up from $647,200 in 2022. In some high-cost locations a single-family loan for a one-unit property could be as large as $1,089,300. The high-cost limit also applies in Alaska, Hawaii, Guam, and the U.S. Virgin Islands. The FHA’s reverse mortgage program uses the high-cost limit nationally.
The conforming limit adjusts annually based on home price appreciation over a one-year period ending in September. The FHFA must raise the limit by an amount that matches the FHFA’s measurement of home price growth over that period. But the limit is not changed if home prices had fallen over that period. Instead, the FHFA will use the declines to offset future increases. This happened after the 2008 financial crisis—the limit was unchanged from 2006 through 2016. The process was codified by the 2008 Housing and Economic Recovery Act (HERA), so changing it would require congressional action.
Home prices grew rapidly throughout 2021 and the first half of 2022 but fell over the two-month period from June to August. However, the FHFA’s price index leveled off in September, which helped maintain a big increase of 12.2%. That is the third largest increase since 1990, surpassed only by an 18% jump this year and a 16% gain in 2006. However, Amherst Pierpont expects home prices to stay roughly flat over the next year, so the limit may not increase for 2024.
Loan size has a large influence on the convexity of mortgage-backed securities (Exhibit 1). The chart shows the theoretical pay-up, calculated using Amherst Pierpont’s prepayment model, for a generic FNCL 5.5% security using a range of loan sizes from $85,000 to $1,085,000. All other attributes of the security are held constant. Smaller balance loans are especially valuable, with theoretical pay-ups increasing to 80/32s for an $85,000 loan compared to a generic $350,000 loan.
Exhibit 1: Theoretical loan balance pay-ups for FNCL 5.5%s.
As-of 11/30/2022 using Amherst Pierpont’s unified prepayment model.
Source: Amherst Pierpont Securities.
A higher loan limit usually causes the average loan size of new loans to increase as well, although the loan size increase is usually less then the loan limit increase. In 2022 the average loan size increase was roughly 40% of the conforming limit increase. That implies the TBA loan size will eventually increase roughly $30,000 in 2023 as those loans worst-to-deliver. That would lower the value of the TBA by 8/32s, which should boost the value of loan balance specified pools by that same amount. Other specified pool stories that also have lower balances, like various low-income lending programs, should also benefit.
Higher loan limits could reduce issuance of private-label securities, since originators will have the option of securitizing loans that are not eligible under the 2022 limits. The issuance of agency jumbo conforming pools is also likely to fall as more high balance loans can be securitized into TBA-eligible pools. Jumbo conforming production fell in 2022 in response to higher loan limits and a shift to a purchase market.
Brian Landy, CFA
blandy@santander.us
1 (646) 776-7795
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