By the Numbers

Big turnover differences from state to state

Brian Landy, CFA | May 19, 2023

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 shift to higher interest rates and to mortgage prepayments dominated by housing turnover has reconfigured the prepayment map. States like California, always known for fast prepayment speeds, have dropped to the bottom of the pack. Leading the way are states in the South, the Southeast and some of the Midwest. Speeds in the fastest states are up to 80% higher than in the slowest states, which is meaningful to valuations of discount MBS. Home price appreciation and equity play a big role.

The fastest speeds over the last six months came in the Southeast and Midwest (Exhibit 1). States like Florida, Alabama and South Carolina had prepayment speeds average as much as 6 CPR over the last six months, which includes the slowest months of the year for housing turnover. The slow states are in the Northeast, upper Midwest and the West Coast. Some states, like New York, are typically slow regardless of rates due high mortgage taxes and closing costs. But the slow speeds from the three West Coast states is a big change from their performance during refinance environments.

Exhibit 1. MBS prepayments were fastest in the southeast and Midwest.

Prepayment speeds from November 2022 through April 2023.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.

Home prices grew at a record pace across the country during the pandemic but varied widely from state-to-state (Exhibit 2). The chart shows cumulative home price appreciation using the FHFA’s home price indices for the 3-year period ended in October 2022, immediately before the 6-month window of prepayments shown in Exhibit 1. Home price appreciation was strongest in the Southeast. Many of these states, especially Florida, experienced in-migration during the pandemic. This tends to create a more vibrant housing market with stronger home prices. States like California and New York experienced net outmigration and lagged the nation in home price appreciation.  The states with strong appreciation tended to have the fastest prepayments over the last six months, and the states with the lowest appreciation tended to have the slowest speeds.

Exhibit 2 Home prices grew the most in the Southeast and some western states.

Cumulative home price appreciation from November 2019 through October 2022.
Source: FHFA, Fannie Mae, Freddie Mac, Santander US Capital Markets.

Home price appreciation moderated substantially last year, falling in some parts of the country (Exhibit 3). This shows home price appreciation for the 6-month period ending in October 2022, and most western states experienced some amount of decline. The Southeast continued to lead the way, although growth was much slower than during the pandemic. However, states like Arizona that experienced near-term depreciation were still faster prepaying states over the last six months. This suggest that long term home price appreciation and home equity accumulation is more meaningful to turnover than short term trends.

Exhibit 3. Home price depreciation has been concentrated in western states.

Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.

Smaller loans, all else equal, tend to turnover more frequently than larger loans. Midwestern and southern states tend to have the least expensive homes and smallest loans, and many of these states have been prepaying faster (Exhibit 4). One example is Kentucky, which is in the smallest loan size bucket but in the second-fastest prepayment speed group. California and New York stand out at the top-end of the loan size range and have had some of the slowest prepayment speeds.

Exhibit 4. States with smaller loans tended to have faster turnover.

Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.

The increased use of property inspection waivers likely helped lift prepayment speeds during the pandemic compared to previous refinance waves. Fannie Mae and Freddie Mac expanded the program to home purchases a few years ago, but fewer homes qualify compared to the waiver rate for refinancing. Over the last six months waivers were offered at the highest rates in western states, and least frequently offered in the Midwest and South. Many of the states with high waiver rates had slow prepayments speeds over those months, and many states with lower waiver rates had faster prepayment speeds. So the waiver program might save borrowers money but may not have much influence over the decision to buy a new home.

Exhibit 5. Property inspection waivers don’t matter much for turnover.

Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.

Cash-out refinancing can also contribute to prepayment speeds of discount MBS. Fewer borrowers are using cash-out refinancing after mortgage rates increased, but they still account for almost 15% of originations in some states. However, there is a lot of dispersion in cash-out originations from state to state (Exhibit 6). This shows the percentage of new Fannie Mae and Freddie Mac issuance that was cash-out refinances. Many of the faster prepaying states had lower cash-out rates, while heavy cash-out states like California had slower prepayment speeds. This suggests that cash-out activity may be masking some of the underlying turnover differences in these states—lifting speeds in slow turnover states more than in fast turnover states. This could be an indicator of how a borrower chooses to spend his home equity.  A borrower in a state with a strong housing market may choose to use equity to buy a more expensive home rather than cash-out for other purposes.

Exhibit 6. Cash-out refinancing rates vary from state to state.

Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.