By the Numbers
Paying cash for carry: current best value in spec pools
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.
Discount MBS pools backed by Texas, Florida and high LTV loans offer the best carry relative to TBA pools, at least based on their latest prepayment speeds. Many of these spec pools would earn back their price premium to TBA in less than a year if current conditions persist. Pools backed by loans with targeted balances take longer to breakeven than pools characterized by geography or LTV, mainly because of higher price premiums. But within the market for loan balance, pools backed by higher balances breakeven faster than loans backed by smaller balances.
In the 1.5% coupon, pools backed by Texas and Florida collateral both prepaid quickly enough in May to earn back their pay-ups in less than two months assuming speeds and current market conditions persist (Exhibit 1). Only five cohorts exceeded the $1 billion threshold for inclusion in this analysis, and three of those were negative carry compared to generic collateral. But the 2020 Texas cohort would earn back its 2.5/32s pay-up in less than one month, and the Florida cohort of that vintage in less than two months.
Exhibit 1. Texas 1.5% pools had a 4-month breakeven at May’s speed.
As of 6/13/2024. Cohorts have at least $1 billion outstanding. Cohort prices from BVAL and carry calculated with Yield Book, TBA carry is market drop from Santander Agency MBS trading desk. 1M CPR is May 2024, 3M CPR is March 2024 through May 2024.
Source: Yield Book, Bloomberg, Santander US Capital Markets.
The table shows the 1-month speed for each specified pool type and current implied CPR for TBA of that coupon. The table is sorted by the highlighted column, with the shortest breakeven times at the top. For example, in May the 2020 Texas pools prepaid at 8.6 CPR, while the market implied speed is 2.2 CPR the TBA as of 6/13/2024. The cohort’s carry is 4.3/32s higher than the current carry of the TBA, so it would earn back it’s 2.5/32s pay-up in only 0.6 months. The right-hand side of the table repeats the calculations using the trailing 3-month CPR for the cohort and worst-to-deliver. Both the Texas and Florida cohorts still breakeven in less than two months at those speeds.
Home price appreciation has cooled off in both Texas and Florida, which could signal slower housing turnover and prepayment speeds in the future. Appreciation slowed in Texas earlier than Florida, so it is encouraging to see speeds remain strong in Texas despite the slowdown. However, Florida pools may be at greater risk that the effect of HPA on turnover has not had time to show up in speeds, and those pools could perform worse going forward.
The best carrying cohort in the 2% coupon was the high LTV 2021 cohort, followed by a few vintage Florida and Texas pools (Exhibit 2). More cohorts exceed the $1 billion threshold in this coupon, so only the 10 cohorts with the shortest breakeven times are shown. The 2021 high LTV had a relatively low 10/32s pay-up and a 1.2/32s carry advantage, so breaks even in 8.3 months. The next best cohort was the 2021 Florida, which takes about 46 months to breakeven. Compared to the LTV cohort this has a higher pay-up and a lower carry advantage.
Exhibit 2. High LTV 2%s had a 9-month breakeven at May’s speed.
As of 6/13/2024. Cohorts have at least $1 bn outstanding; ten best cohorts shown. Cohort prices from BVAL and carry calculated with Yield Book, TBA carry is market drop from Santander Agency MBS trading desk. 1M CPR is May 2024, 3M CPR is March 2024 through May 2024.
Source: Yield Book, Bloomberg, Santander US Capital Markets.
The market drop for the 2% coupon has the dollar roll roughly 1/32s special, which extends the breakeven times in this coupon. However, some sources do not have this roll special. The roll is early in the monthly cycle, and little trading has occurred so far for this coupon. That may explain the discrepancy. If the roll is not special the breakeven times would be shorter. And investors that cannot roll would also see shorter breakeven times than shown in the table.
The shortest breakeven time in the 2.5% coupon was the non-owner occupied 2020 (Exhibit 3). The Bloomberg “OCC” cohort is primarily 100% investor pools but can include second homes in recent vintages. The very low 0.9/32s pay-up is earned back in less than a month. Texas and Florida pools also fared well in this coupon, with breakeven times within a year. All of the listed cohorts breakeven within 2 years at both the 1-month and 3-month CPRs.
Exhibit 3. Texas pools had the shortest breakeven times in the 2.5% coupon.
As of 6/13/2024. Cohorts have at least $1 bn outstanding; ten best cohorts shown. Cohort prices from BVAL and carry calculated with Yield Book, TBA carry is market drop from Santander Agency MBS trading desk. 1M CPR is May 2024, 3M CPR is March 2024 through May 2024.
Source: Yield Book, Bloomberg, Santander US Capital Markets.
The ten best performing cohorts in the 3% coupon each earn back their pay-up in less than a year (Exhibit 4). This is also true for the 3-month CPR, except for the 2021 Florida cohort. But that still recoups the pay-up in under 14 months. High LTV, Florida, and Texas cohorts once again make the top 10. A couple New York cohorts make the cut, primarily because of very low pay-ups and low carry on the TBA in this coupon.
Exhibit 4. The top cohorts in this coupon earn back pay-ups in under a year.
As of 6/13/2024. Cohorts have at least $1 bn outstanding; ten best cohorts shown. Cohort prices from BVAL and carry calculated with Yield Book, TBA carry is market drop from Santander Agency MBS trading desk. 1M CPR is May 2024, 3M CPR is March 2024 through May 2024.
Source: Yield Book, Bloomberg, Santander US Capital Markets.
Discount specified pools generally offer better carry than generic TBA pools. Typically, low pay-up pool types are projected to earn back their pay-ups fastest. Low loan balance pools, which often command the largest pay-up, tend to take the longest time to pay it back. Of course, the pay-up for loan balance also reflects the slower rate of refinancing in those pools, and the potential value of holding them if interest rate drop in the future. But across the 1.5% through 3.0% coupons, Florida, Texas, and high LTV pools have generally prepaid quickly with lower pay-ups so tend to provide a better value to investors trying to maximize immediate carry and return.
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