Prepay Speeds Fall Sharply in April Reports

Prepayment rates for 30-year mortgages in Fannie Mae and Freddie Mac mortgage-backed securities fell by about 15% in April, according to Bear Stearns & Co.

The aggregate prepayment rate on 30-year Fannie Maes was a constant prepayment rate of 11.4 CPR, down 16% from 13.6 CPR in March, Bear Stearns analysts Dale Westhoff and V.S. Srinivasan reported. The aggregate speed on Freddie Mac 30-year collateral fell 15%, from 11.8 CPR in March to 10.0 CPR in April.

"Improving seasonal factors affecting turnover gave way to the drag imposed by a three-day decline in business calendar and a [9-basis-point] back-up in rates," the Bear Stearns analysts said.

The 30-year 6.0% coupons recorded the largest percentage speed decline, while declines in the 5.5% and 6.5% coupons were "slightly smaller" and those in the 4.5s and 5.0s were "noticeably smaller."

Despite the slowdown, the analysts said discount speeds, adjusted for relative coupon and seasoning, "remain well above historical norms. ... These elevated speeds are a strong indication of the continued influence of cash-out refinancing on fixed-rate prepayments."

Nevertheless, the "risks are biased" toward slower discount speeds in view of the phase of the interest rate and housing market cycles, they said.

The analysts noted that Freddie Mac speeds are still "marginally slower" than Fannie Mae speeds across most 30-year coupons and vintages.

In other sectors, overall prepayments on 15-year Fannie and Freddie collateral declined 10% in April, while the speeds of discount agency hybrids "declined less than their fixed-rate counterparts, highlighting the extension protection offered by this sector of the mortgage market."

The analysts forecast that agency speeds would increase 10% to 15% in May, based on a seasonal pickup in housing turnover and a two-day expansion in the business calendar.

But in the longer term, "we would expect a steady decline in speeds driven by the 30 bp sell-off in rates over the last few weeks," the Bear Stearns analysts said. "With 30-year mortgage rates at four-year highs, only 5% of the outstanding fixed-rate mortgage universe is refinanceable."

In related news, analysts Westhoff and Srinivasan reported in the May issue of Short-Term Prepayment Estimates that Bear Stearns has enhanced its fixed-rate agency prepayment models.

The two key components of the update are an increase in the impact of home price appreciation by 1.0-1.5 CPR, and a change in the impact of historical rates on "the pure housing turnover function," they said.

"The first change is fairly intuitive and is backed by recent historical data," the analysts said. "It is clear that borrowers have become more willing to extract the equity in their property, and our first change incorporates this behavior into the discount function."

The second change stemmed from the results of a recent study of mortgage option-adjusted spreads.

"In the study we showed that discount prepayment projections in sustained high interest rate paths have a significant impact on mortgage valuations," the Bear Stearns analysts said. "While there is little empirical data on how borrowers behave if they hold a deep discount mortgage over an extended period of time, it is reasonable to assume that at some point the demographic pressure to move will overwhelm the incentive to hold the discount mortgage."

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