By the Numbers
To roll or not to roll as MBS refi activity picks up
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.
The dollar roll market has quickly reflected expected rising prepayment speeds in the next few months, raising the question of whether to roll or not. Lower mortgage rates in September will likely have the largest effect on prepayment speeds in 30-year 5.5%, 6.0% and 6.5% MBS. But worst-to-deliver pools in those coupons should prepay slower than the speeds priced in the October-to-November roll, so it looks better not to roll TBA-eligible positions.
The MBA’s refinance index increased over the last two weeks, jumping past 1,000 for the first time since April 2022 (Exhibit 1). High mortgage rates have prevented most borrowers from refinancing. But rates have been falling steadily since May and the index has edged higher at the same time. The jump over the last couple of weeks reflects lower rates in early September, which made refinancing economical to more borrowers. The refinance index is still far below levels seen in earlier refinance waves; for example, at times it exceeded 4,000 in 2020 and 2021.
Exhibit 1. Mortgage Bankers Association refinance index, seasonally adjusted.
Source: Bloomberg, Mortgage Bankers Association, Santander US Capital Markets.
Lower mortgage rates since the end of August put more borrowers in the 5.5% through 6.5% coupons in-the-money to refinance (Exhibit 2). For example, at the end of August only 2.8% of FNCL 5.5% borrower were at least 75 bp in-the-money to refinance; that has jumped to 17.1% in-the-money. Similarly, 40.8% of FNCL 6.0%s were in-the-money, and that has increased to 71.7%, respectively, after rates dropped. Lower rates had a smaller effect on the number of refinanceable borrowers in 6.5%s and almost no effect on the number of borrowers in 7.0%s, since these coupons were already deep in-the-money.
Exhibit 2. Percent of borrowers at least 75 bp in-the-money.
In-the-money loans have at least 75 bp incentive to refinance.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
Speeds should accelerate in these coupons over the next couple of months (Exhibit 3). The 6.0%s, 6.5%s, and 7.0%s all should increase in September, and the recent rally will likely push those speeds even faster in October. And the 5.5%s, which have been on the sidelines until now, should begin to prepay faster from refinancing in October.
Exhibit 3. Speeds on 5.5%s and above will increase in September and October.
Prepayment speeds calculated from Fannie Mae’s and Freddie Mac’s weekly releases of daily prepayment data. September speeds are estimated using the first seven business days of the month; October is projected with Yield Book on the worst-to deliver vintage.
Source: Yield Book, Fannie Mae, Freddie Mac, Santander US Capital Markets.
Dollar rolls in 5.5%s and 6.0%s are currently priced to faster speeds than the projected speeds for worst-to-deliver collateral in these coupons (Exhibit 4). Since these are premium coupons, rolling TBA-eligible pools in those coupons does not look worthwhile. Investors should not roll TBA-eligible pools priced above par if the projected speed is less than the breakeven speed and should roll those pools if the projected speed is greater than the breakeven speed. Speeds on the 6.5%s and 7.0%s are closer to the breakeven speeds—the 6.5%s are projected to be slightly faster than the breakeven, and 7.0%s slightly less than the breakeven. Neither coupon presents a strong case for deciding whether to roll.
Exhibit 4. Dollar rolls are pricing in faster speeds than expected in 5.5%s and 6.0%s.
As of 9/25/2024 close. Projected speeds run using worst-to-deliver collateral—5 WALA for 5.5%s and 6.0%s, 9 WALA for 6.5%s and 7.0%s—in Yield Book.
Source: Yield Book, Santander US Capital Markets.
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