April 2020 MBS Prepayment Speeds
April factors were recently released (reflecting activity in March), and prepayment speeds increased markedly from February. If you are wondering how prepayments could have increased, given everything that is going on, below is a table summarizing the timing of prepayments.
Last month I wrote that I’d expect prepayments to increase/remain elevated for the next couple months (April and May) as mortgage rates were overall lower. So far that has played out in April, and if we consider the table above, I think there is a compelling case to be made for speeds at least remaining elevated in May as well.
I called Covid-19 a wild-card last month in terms of future activity. It now seems a foregone conclusion that, in June, we are going to see prepayments slower than we would normally expect. Decreased housing turnover, social distancing, job losses, qualifying for a mortgage, forbearance, all these things should pressure prepayments down.
Fed Starts Purchasing MBS
Also, since our last publication, the Fed has instituted several asset purchase programs designed to provide liquidity to markets. One of which, is the Agency MBS market as spreads careened out of control.
No doubt, Fed purchases have caused prices to increase and spreads to tighten. Here are a couple examples.
- 2019 Production 30-Year 2.5 MBS have increased in price by approximately 4 points (from $100 to $104) from lows in mid-March.
- 2019 Production 15-Year 2.0 MBS have increased in price by approximately 3.5 points (from $99.5 to $103) from lows in mid-March.
Food for Thought
I mentioned forbearances earlier, without a doubt, this is the single most-talked-about topic in the mortgage market today. Currently, there is still much unknown, other than forbearances are being granted, to know exactly how this will play out. This will put stress on servicers (especially non-bank servicers), though how much remains to be seen. Essentially, the issue boils down to timing. Servicers may have to forward more payments than their liquidity position can handle, even if they will be reimbursed. I want to focus on investors in Fannie and Freddie MBS and what we know.
- Fannie/Freddie guarantee the timely payment of Principal and Interest.
- In the event a payment is missed, the servicer is responsible for advancing the payment.
- Servicers are reimbursed by Fannie/Freddie for any advanced payments.
- Both the Treasury and FHFA are (and have been) aware of this issue.
- The most likely solution, if deemed necessary, will be a liquidity facility designed to ease any “cash crunch” until Fannie and Freddie reimburse a servicer.
Mortgage Rates – Freddie Mac Primary Mortgage Market Survey
What We’re Reading
“Fifteen financial industry trade associations and affordable housing advocate groups issued a joint statement on Saturday calling on the Federal Housing Finance Agency, the Federal Reserve and the Department of the Treasury to establish a liquidity facility for servicers as a follow up to the mortgage forbearance provided by the CARES Act.”
“But members of the Financial Stability Oversight Council, a panel of regulators led by Treasury Secretary Steve Mnuchin, have discussed holding off on setting up such a program to see if other policies put in place recently effectively ease liquidity shortfalls, said the people who requested anonymity because the talks are private.”
This is a short presentation looking at the use of prepayment models and how they have evolved over time. A good prepayment model should help you better understand the risks of an investment. No prepayment model is perfect; after all, they are trying to predict the future. However, some are more robust than others and will take pool specific attributes into account such as, geographies, loan balances, and even who the servicer is.
Notables – Excludes vintages of marginal size
- The fastest 15-Year UMBS cohort for the month was 2018 production 15-Year 3.5s at 31.2 CPR.
- The fastest 20-Year UMBS cohort for the month was 2018 production 20-Year 4.0s at 35.1 CPR.
- The fastest 30-Year UMBS cohort for the month was 2018 production 30-Year 4.0s at 44.0 CPR.
Kevin A. Smith, CFA
SVP, Director Investment Product Strategies
Analyst, Investment Product Strategies