August 2020 MBS Prepayment Speeds
August factors were released last evening (reflecting activity in July), and prepayment speeds are now available. Conventional speeds largely increased; however, there were some declines (technically) in higher coupons that already have some investors rooting for burnout. The declines are so small though that it could just be “noise”. As always, we’ll know more next month. GNMA speeds were generally higher on lower coupons and slowed down on higher coupons.
Looking forward, I think it is likely prepay speeds remain elevated unless something drastic changes. COVID-19 has not affected single-family housing like many expected (myself included) since the outset of the pandemic. Housing continues to be resilient and those who can refinance will likely continue to do so. Mortgage rates have continued to fall and currently sit at all-time lows as measured by the Freddie Mac Primary Mortgage Market Survey (see section below).
Food for Thought – Prepay Protection Continues to Look Compelling
As the Fed has driven prices higher on MBS, many investors have looked for ways to mitigate, or at least decrease, the prepayment risk inherent in MBS bonds. One of those ways is to look at specified pools with lower loan balances than a more generic pool. 100% New York pools are also popular as state taxes make it harder for a refi to make economic sense. Mathematically (and intuitively), we know a lower loan balance and/or higher fixed cost, all else equal, requires a larger rate decrease for a refinance to make economic sense for the borrower. There is history to support this.
For example, let us consider the 30-year 3% MBS issued in 2019 (FNCL 3 – 2019) against “loan balance” pools of the same vintage, such as the 30-year 3% MBS issued in 2019 with a maximum loan size of $125,000 (FNCL 3 – 2019 LB 125). For the most recent reading, the generic 30-year 3s of 2019 had a trailing 1-month CPR of 41 compared to 12 for the “125K max” pools issued in the same year. You can also see the 100% NY collateral has behaved favorably as well.
Yes, there is a “pay-up” associated with loan balance or 100% NY pools. However, given what we know coupled with historical evidence, the pay-up could be worthwhile as a form of insurance against prepayments.
Looking Back, It is Amazing the Range of Speeds Experienced in 2020
Primary/Secondary Spread – Remains Elevated as Mortgage Rates Decline
Mortgage Rates – All Time Lows on 15- and 30-Year Mortgage Rates
What We’re Reading
“One obvious question is whether this rush to the suburbs is fueling a bubble. In late July the median home price was up 11% from a year ago, according to Redfin. An index that better adjusts for the type and location of homes was up 4.9% in May.”
Kevin A. Smith, CFA
SVP, Director Investment Product Strategies
Analyst, Investment Product Strategies