By the Numbers
Heightened refinance risk in recent MBS vintages
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Falling mortgage rates have raised the risk of refinancing in certain MBS cohorts. Although rates were a little lower to start the year compared to today, most borrowers that had good incentives to refinance were not seasoned enough to do so. And the few borrowers with high-rate loans and enough seasoning likely faced credit concerns that prevented them from receiving a market rate loan. But many loans originated in the last few months of 2023 should be able to take advantage of this opportunity to refinance. Most of these loans are in 6.5% pools and higher, but the low mortgage rates available to VA borrowers could trigger prepayments in Ginnie Mae 6.0%s.
At current rates there are a substantial number of conventional loans in 6.5% and higher coupons that can refinance (Exhibit 1). Any loan with at least 75 bp of rate incentive to refinance and at least six months seasoning is considered refinanceable. In the 6.5% coupon, 55.0% of loans are considered refinanceable. That number jumps to nearly 96% in the 7.0% coupon and almost 100% in the 7.5%s. However, these coupons are still small compared to the overall amount of agency MBS outstanding, so only 2.9% of all loans are in-the-money. Mortgage rates would need to drop below 6% to push just 10% of loans in-the-money.
Exhibit 1. A large share of conventional 6.5%s and higher are in-the-money to refinance.
In-the-money loans have at least 75 bp incentive to refinance.
Source: Bloomberg, Fannie Mae, Freddie Mac, Santander US Capital Markets.
Since most of the high-coupon loans were originated in late 2023, many loans were less likely to refinance when rates dropped at the end of the year. Lenders typically do not want to encourage early refinancing, so loans less than six months seasoned tend to prepay slowly. Many of the high coupon loans were originated in late 2023 are now surpassing that threshold, so speeds should increase on those cohorts.
In Ginnie Mae MBS, a greater portion of the 6% cohort is in-the-money compared to conventional (Exhibit 2). Roughly 21.9% of that coupon is refinanceable compared to 5.2% in conventional. A big factor is that VA loans have been receiving much lower refinance rates than other loans. The highlighted column shows the current FHA mortgage rate of 6.28%, but the rate incentive for VA loans is measured against a 5.79% market rate. Loans pooled in November and December 2023 will become seasoned enough to refinance over the next couple of months, and VA speeds should jump as that happens. FHA loans will also prepay faster, but not to nearly the same degree.
Exhibit 2. Seasoning blocks many new FHA and VA loans from refinancing.
In-the-money loans have at least 75 bp incentive to refinance. The VA rate used is 5.79% and the FHA rate is 6.28% as of 7/17/2024 and maintain a constant spread in the table’s rate scenarios.
Source: Bloomberg, Ginnie Mae, Santander US Capital Markets.
VA loans have a steeper S-curve than FHA loans, with much faster peak speeds. But the different refinance rates means that VA loans will be further in-the-money than FHA loans in the same coupon.
All of the currently refinanceable cohorts were originated in 2023 and 2024 (Exhibit 3). This table shows the largest two conventional cohorts for each coupon. Furthermore, the higher rate loans were mostly originated in the last three months of 2023, since rates peaked in October. That means that when rates fell in mid-December and stayed low through mid-February most of these loans were unable to take advantage of the refinance opportunity. This is a big reason that conventional speeds were slow. However, most of those loans are reaching, or past, 6 wala and are likely to prepay faster over the coming months.
Exhibit 3. Other than the 6.5%s and 7%s of 2023, most conventional cohorts are far from refinanceable.
In-the-money loans have at least 75 bp incentive to refinance.
Source: Bloomberg, Fannie Mae, Freddie Mac, Santander US Capital Markets.
The largest refinanceable Ginnie Mae cohorts were also originated in 2023 and 2024 (Exhibit 4). And most of the high-rate loans were originated in late 2023, unable to refinance early this year. Speeds on the handful of VA loans that were able to refinance were extremely fast, and speeds have begun to pickup on pools issued in October 2023. Expect that to spread to pools issued in November and December over the next couple of months.
Exhibit 4. Ginnie Mae refinanceability by cohort.
In-the-money loans have at least 75 bp incentive to refinance. The VA rate used is 5.79% and the FHA rate is 6.28% as of 7/17/2024 and maintain a constant spread in the table’s rate scenarios.
Source: Bloomberg, Ginnie Mae, Santander US Capital Markets.
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