By the Numbers
Higher insurance premiums could lift California housing turnover
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.
Even though California’s current wildfires look likely to have limited direct impact on agency MBS, their indirect impact through rising insurance premiums could be meaningful. Higher premiums would raise the cost of homeownership for existing homeowners, some of whom may not be able to afford the higher payments. That should drive up housing turnover. Some private insurers have already left the state, forcing borrowers into California’s backstop insurance program, which might also need to raise premiums or require a tax increase. California housing turnover could rise by 0.5 CPR and affect many loans in agency MBS pools trading well below par. For example, non-investor California loans account for 22.3%–nearly $310 billion—of loans in FNCL 2%s.
The best opportunity looks likely to come in 30-year 1.5%s, 2%s and 2.5%s, which currently are trading at $73-19, $77-15+ and $81-05+, respectively. Changes in prepayment speeds have the largest effect on the value of pools trading at deep discounts to par. These coupons also have the highest exposure to non-investor California loans, ranging from about 15% to over 27% (Exhibit 1). However, finding pools with high California concentrations is challenging since investors typically do not want pools with significant California exposure. For example, $168,960 mm UPB is available of pools with at least 30% California exposure and less than 5% investor exposure, after excluding UPB held by the Fed or locked into CMOs. This is about 12.2% of the cohort. But there is only $8.2 billion of 2% pools available with at least 40% California exposure.
Exhibit 1. Discount coupons have the largest exposure to California loans.
Pools issued in 2020 and later. The “% CA and non-investor” column shows the share of the cohort that are non-investor California loans. The last four columns show the UPB available—after removing UPB owned by the Fed and locked into CMOs—of pools with less than 5% investor loans and at least the stated percent of California loans.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
The experience in Florida
Florida has faced a similar situation over the last few years. Frequent hurricanes and rising costs have caused some insurers to leave the state. Enrollment in Florida’s state-run insurance program has jumped from just over 400,000 policies in 2019 to a peak of 1.4 million policies in late 2023 (Exhibit 2). The state has made progress over the last two years in placing people with private insurers to shrink the program, but still has around 1 million active policies. This program is intended to be an insurer of last resort but had to expand to accommodate the surge in borrowers that could no longer acquire private insurance.
Exhibit 2. Policies written by Florida’s property insurance company.
Source: Citizens Property Insurance Corporation of Florida, Santander US Capital Markets.
Higher insurance premiums increase the cost of homeownership for existing borrowers, not just new borrowers. Most people have fixed rate loans, so the principal and interest payments do not change over time. But property taxes and hazard insurance can push payments higher, and some borrowers may not be prepared for those increases. According to analysis from ICE, hazard insurance accounts for about 10% of the mortgage payment for the average loan originated before 2022. People that stretched to buy homes in 2020 and 2021 as home prices jumped may not be able to handle larger payments, especially after the heavy inflation since early 2021.
Prepayment speeds of out-of-the-money loans in conventional agency MBS were typically faster in Florida than in other states following the 2022 and 2023 hurricanes (Exhibit 3). This chart plots speeds for loans with no rate incentive since 2017, comparing loans in Florida to loans in Midwestern states unaffected by hurricanes. Florida loans have prepaid faster following Ian in late 2022 and Idalia in late 2023, averaging 0.9 CPR faster in 2023 and 2024 compared to 0.3 CPR faster from 2014 through 2017. Rising insurance costs may be contributing to increase.
Exhibit 3. Housing turnover in Florida outpaced a basket of midwestern states following hurricanes in 2022 and 2023.
Data from March 2020 through February 2021 is excluded because of low numbers of discount loans. The chart linearly interpolates over the missing months. Fixed-rate, 30-year, owner-occupied, at least 6 months seasoned. Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
The data also includes buyouts, which Fannie Mae and Freddie Mac do not identify at the loan-level. However, starting in 2021 the GSEs do not automatically buyout loans that are four months delinquent. Buyouts likely inflated speeds following Irma and Michael in 2017 and 2018, but likely had little effect after Ian and Idalia. Other factors may also contribute to faster housing turnover in Florida—for example, it has been a hot housing market since 2020.
It is also possible that there will be a larger shock to the California insurance market than there has been to the Florida market. Insurers may not have anticipated that such large fires could occur in a major metropolitan area like Los Angeles, assuming well-funded fire departments were better equipped to handle the risk. The shock to insurance availability and premiums may be larger than it is following the typical Florida hurricane. This means there could be a larger effect on California turnover compared to Florida.
California also has a program that acts as a lender of last resort, FAIR. The number of residential policies increased 123% from September 2020 until September 2024 and 41% in the last year. It is already dealing with rapid growth that could accelerate over the coming months.
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