August MBS Prepayment Speeds
August factors are out and prepayments are up across the board. It should not come as a surprise though. As we wrote last month, the expectation was for speeds to increase this month as mortgage rates were lower during the applicable refi window; plus, add in a couple extra business days, and you have a recipe for faster prepayments. Next month will likely see prepayment speeds increase again. Since August 1st, just 6 days ago, 7-year and 10-year Treasury yields are down 23 and 26 bps, respectively. If rates remain at or near these levels, it speaks to higher prepayments in October since refinancings typically take thirty to forty-five days to close.
Notables and Thoughts
- In MBS, we are seeing depositories trade out of shorter (often higher-coupon) 15-year MBS as they seek to protect their margins in a falling rate environment. Reinvestment has varied, but more “call protected” cashflows (think CMBS, cut-coupon CMOs, Munis, etc) is a common denominator.
- In CMOs, we have seen more investors considering “cut-down” coupon (e.g. 3.0 coupon off of 4.0 collateral) to lower the price and risk to underperforming yields.
- Given this continued and sustained decline in rates and corresponding increase in prepay speeds, it is worth looking at your projected yields, that is, the expected yield moving forward given current prepayment expectations as they have likely changed since your initial purchase.
- For this to be truly effective, you need to use a “real” prepayment model. Yield Book or Bloomberg’s new BAM Model, for example.
- We can help you with this in a variety of ways, but one you may already be familiar with is to simply request a Performance Profile. If you’re not sure where to turn, feel free to reach out to me directly.
Based on the Freddie Mac Primary Mortgage Market Survey, 30- and 15-year fixed-rate mortgage rates are at their lowest levels since 2016. This year alone, 30- and 15-year mortgage rates are down 76 and 79 bps, respectively.
“Lenders made $565 billion of mortgage loans in the second quarter, the most in more than two years. At that pace, originations could exceed $2 trillion for only the third year since the financial crisis, according to Inside Mortgage Finance.”
“Most depositories have positioned their balance sheets for rising rates. Naturally, this came with increased exposure to falling rates. Given that interest rate risk has become more bidirectional in nature and the market is signaling a Fed ease, the question to ask right now is, should we begin to hedge against falling rates?”
Kevin A. Smith, CFA
SVP, Director Investment Product Strategies
Analyst, Investment Product Strategies