By the Numbers

Latest speeds put MBS negative convexity on display

| October 7, 2024

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.

Prepayment speeds for conventional mortgage-backed securities accelerated beyond model projections in September, while discounts slowed more than projected. Discounts moved in-line with day count and typical seasonal factors, with most lower coupons falling 10% to 15%. Yield Book’s model has projected many of these coupons to prepay slightly faster, in response to lower mortgage rates. Premium coupons like 6%s through 7%s increased 32% to 40%, exceeding Yield Book’s projections in those coupons. Cohorts like the FNCL 6.5%s 2023 jumped more than 55% and non-specified pools in that cohort prepaid over 60% faster.

Ginnie Mae speeds increased more than conventionals in many coupons. Speeds in 5.5%s increased 45% and in 6.0%s increased 47%. Fast prepayments from VA loans are a big reason for this difference. Those borrowers typically receive lower mortgage rates than other borrowers, which means the G2SF 5.5% cohort was further in-the-money than the FNCL 5.5% in September. However, deep in-the-money coupons like 7%s and 7.5%s have reached peak speeds and are even starting to slow as burnout develops in those coupons.

Mortgage rates fell in September, which should push speeds even faster in October. Conventional 5.5%s should show more signs of refinance activity. The the MBA’s purchase index picked up this month, suggesting that the typical October seasonal decline should be muted.  Two additional business days should also lift speeds. Expect discounts to be roughly flat month-over-month while premiums continue to move faster as more loans, and loans in conventional 5.5%s and Ginnie Mae 5.0%s, start to refinance. Speeds in 5.5%s through 6.5%s could increase 50% or more and overall speeds around 15 to 20%.

Cohort-level prepayment data is available here.

Exhibit 1: September 2024 Agency Prepayment Speeds, % Change

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

Conventional MBS displayed greater negative convexity in September compared to projections from Yield Book (Exhibit 2). The left-hand section of the table compared Yield Book’s projections to the actual prepayment speeds for conventional 30-year MBS cohorts in Bloomberg’s MBS index. Yield Book’s forecasts were slower in premiums and faster in discounts. The right-hand side shows the month-over-month percent change from August to September, which sows that Yield Book expected faster premium speeds but underestimated the increase, and in discounts expected speeds to increase but instead speeds slowed.

Exhibit 2. Yield Book underestimated conventional negative convexity in September.

Includes only cohorts that are in Bloomberg’s MBS index. GSE weekly data projection excludes pools issued in September.
Source: Fannie Mae, Freddie Mac, Yield Book, Santander US Capital Markets.

Behavior was similar in Ginnie Mae MBS (Exhibit 3). Yield Book underestimated premium speeds and overestimated discount speeds. The misses were especially large in 5.5%s and 6.0%s. In the 5.5%s, for example, Yield Book expected speeds to be unchanged but instead they jumped 59.5. This likely means that Yield Book is not using a low-enough mortgage rate for VA loans, so it thinks loans are out-of-the-money, but those loans are in-the-money and refinancing. VA borrowers typically receive lower mortgage rates than other borrowers, but the gap has been wider than usual this year.

Exhibit 3. Yield Book also underestimated Ginnie Mae negative convexity in September.

Includes only multiple-issuer cohorts that are in Bloomberg’s MBS index.
Source: Ginnie Mae, Yield Book, Santander US Capital Markets.

As expected, most 6.5% low-loan balance specified pool types had smaller month-over-month percent increases than generic pools (Exhibit 4). And even when the percent change was higher for a specified pool type, as it was for the Max $275k, the absolute speed increase was still smaller. However, contrary to our expectations, Yield Book’s performance was not better for low-loan balance pools than for generic pools. In the smallest loan size cohorts, Yield Book expected speeds to slow modestly yet instead they increased; this was because Yield Book was already too slow on those cohorts in August.

Exhibit 4. Yield Book was slow on conventional 6.5% low loan balance pools.

Source: Ginnie Mae, Yield Book, Santander US Capital Markets.

In Ginnie Mae 6.5%s, many low-loan balance cohorts had larger percent changes than the worst-to-deliver (Exhibit 5). Performance as better in the smaller loan size cohorts, probably due to a lower share of VA loans. Yield Book’s performance was similar to its performance in conventional 6.5%s—it was slow across the pool types and under predicted the month-over-month increases.

Exhibit 5. Yield Book as slow on Ginnie Mae 6.5% low loan balance pools.

 Source: Ginnie Mae, Yield Book, Santander US Capital Markets.

Brian Landy, CFA
brian.landy@santander.us
1 (646) 776-7795

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