'Extension Theme' Suggests Prepays Will Slow

Prepayment rates for mortgage-backed securities fell 10.5% overall in July from a constant prepayment rate of 11.9 CPR to 10.7 CPR, according to Credit Suisse.

Credit Suisse researchers Mahesh Swaminathan and Mukul Chhabra, writing in the July 2008 Fixed Rate Prepayment Commentary, reported that the speeds of 30-year 2007 5.5% coupons slowed by 1 CPR, while 6.0% and 6.5% coupons declined 2 CPR.

The Credit Suisse analysts also reported that the estimated net issuance of fixed-rate MBS plunged from $60.4 billion in June to $35.8 billion, a decline of 40.8%.

The estimated net issuance of 30-year Fannie Mae and Freddie Mac MBS fell from $39.6 billion to $19.8 billion, while estimated issuance of 30-year Ginnie Mae securities declined from $20 billion to $18.7 billion, the authors said.

"The extension theme is reinforced, with diminishing prepayment activity likely to continue for the rest of this year," the Credit Suisse analysts said. "Speeds across the coupon stack are likely to compress if rates grind higher."

For example, they said, the speeds of Fannie Mae 30-year 5.5% coupons "could very well" fall from 4.4 CPR in July to 3 CPR over the winter.

In other prepayment-related news, Barclays Capital observed in the Aug. 25 issue of US MBS Strategy that discount speeds "have yet to feel the full impact of weak housing" because mortgage rates have been relatively low in the past year, but added that this is likely to change.

"Rapidly rising inflation suggests that interest rates are due to rise," Barclays analysts said. "While this may not occur by year-end, higher interest rates in the future seem imminent. When this does occur, mortgage prepayments should slow further, leading mortgages to extend significantly."

Because extension protection would then become a "major concern" for many investors, the analysts performed an analysis of total rates of return. They declared 5/1 hybrid adjustable-rate mortgages to be "the clear winners," finding that they "consistently prepay 5-10 CPR faster" than 30-year discount collateral.

In an earlier report, Barclays Capital opined that the inclusion of larger-balance loans in future MBS as a result of newly adopted loan limits for the government-sponsored enterprises is likely to have minimal effects on prepayments.

"In the MBS universe, we are indoctrinated with the mantra that higher loan size equates to increased prepayment risk," the Barclays analysts said in the Aug. 11 issue of US MBS Strategy. "However, this only applies up to a certain point."

Citing data on jumbo prepayments by loan size, the analysts said loan size ceases to affect prepayments at about $250,000 to $300,000.

"While many investors are concerned about the prospects of $500K-plus loans making their way into [to-be-announced MBS], in reality there are very little differences in the prepayments for a $300k and a $600k loan," the analysts said.

Barclays also advised investors to "grab extension protection," predicting that prepayments were "poised to slow to levels last seen in the 1990s." Aggregate speeds for agency 30-year MBS are likely to slow to 6-7 CPR in coming months, they said.

Credit Suisse provides private banking, investment banking and asset management services worldwide. The company employs approximately 49,000 people. Credit Suisse is a leading MBS underwriter. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/