By the Numbers

Signs of life in discount MBS speeds

| January 24, 2025

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 prepayment speeds have jumped higher since rates fell in September, defying the typical seasonal slowdown expected at the end of the years. After adjusting for seasonal factors and day count, aggregate speeds of discount collateral have increased by about 1 CPR, a 20% increase, compared to the first nine months of 2024. Speeds have remained strong despite rates increasing in October, raising the possibility that turnover might not return to its prior level. And the MBA’s Purchase Index is still elevated, suggesting strong discount prepays should continue in January and February.

Discount prepayment speeds reached the highest level since mid-2022 in November, after adjusting for seasonals and day count (Exhibit 1). The chart shows the aggregate prepayment speed of all owner-occupied loans in Fannie Mae and Freddie Mac 30-year MBS pools that do are at least 50 bp out-of-the-money to refinance. The right-hand side shows the rate incentive of these loans since borrowers are reluctant to sell homes and prepay a below market rate loan.

Exhibit 1. Housing turnover jumped after mortgage rates dropped in September.

Fixed-rate, 30-year, owner-occupied loans at least 50 bp out-of-the-money. Seasonal adjustment inferred from existing home sales and does not change from year to year.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.

Speeds fell throughout 2022 as mortgage rates increased and rate incentive dropped, although the correlation weakened during the second half of the year. And in 2023 rates had little influence on discount speeds. From late 2022 into early 2023 mortgage rates rallied nearly 100 bp, then increased steadily until late 2023, then they rallied again. But the adjusted prepayment speed didn’t react to those rate changes and stayed between 4.5 CPR and 5.0 CPR throughout the year and until mid-2024.

But speeds increased around 1 CPR from August to December and reached 6 CPR in November. The last time the discount MBS universe had this level of rate incentive was in early 2023, but speeds were only around 5 CPR. And the last time speeds were at the current 6 CPR level was in mid-2022, when rates were lower, and rate incentive was higher.

A sudden jump like this could be a sign of pent-up demand to move. In late 2022, many borrowers had recently moved and were unlikely to need to move again. But in late 2024, after more than two years of high mortgage rates, borrowers may have a greater need to move and be more willing to take advantage of dips in mortgage rates.

Turnover has stayed elevated despite rates increasing in October. It remains to be seen whether this reflects a permanent shift faster. But for the next couple of months speeds should remain elevated. The MBA’s Purchase Index has stayed strong through most of the fall, other than a dip around Christmas, but rebounded higher in January (Exhibit 2). That suggests turnover should remain unseasonably strong in January and February.

Exhibit 2. The MBA’s Purchase index reached its highest levels since the start of 2024.

Source: Mortgage Bankers Association, Bloomberg, Santander US Capital Markets.

The pace of existing home sales also supports the view that housing turnover increased in the fall (Exhibit 3). This series is seasonally adjusted and shifted higher in October and November. Unfortunately, it is a lagging indicator of prepayment speeds so doesn’t provide insight regarding future speeds.

Exhibit 3. Existing home sales ticked higher in October and November.

Seasonally adjusted.
Source: National Association of Realtors, Bloomberg, Santander US Capital Markets.

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

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