Despite Higher Rates, Prepayment Speeds Still Accelerate in July Data

Prepayment rates for agency mortgage-backed securities rose to "unprecedented heights" in the July reporting period, according to the Bear Stearns Prepayment Commentary.

The record speeds extended even to the lowest MBS coupons, and two vintages of 6.0% coupons surpassed constant prepayment rates of 80 CPR for both Fannie Mae and Freddie Mac securities, said analysts Dale Westhoff and Bruce Kramer.

Except for the most seasoned (1993) and least seasoned (2003) cohorts, all vintages of the 6.0% issues recorded speeds of over 70 CPR, they said.

Speeds of Freddie Mac MBS were consistently faster (by 2-5 CPR) than those of comparable Fannie Maes in every new to moderately seasoned vintage from 5.5s to 7.0s, the analysts noted.

"This is a continuation of the trend in GSE prepayments that we have observed and commented on throughout the current refinancing wave," Mr. Westhoff and Mr. Kramer said. "Nevertheless, with mortgage rates now over 100 basis points above their lows in June, we expect to see (Fannie Mae and Freddie Mac) speeds converge over the next four months."

Given the surge of mortgage rates in July and early August, the analysts said they expected prepayments to slow 50% to 80% for 5.5% to 7.0% coupons over the next four reports.

They said the refinancing exposure in the mortgage market had dropped from 96% to less than 40% over the previous eight weeks, and the average refi incentive had fallen from 145 basis points to less than 20 bps.

In a separate publication, Bear Stearns analysts recently predicted that the surge in mortgage rates in July would trigger "massive declines" in prepayments in September and October.

In a "Short-Term Prepayment Estimates" report titled "Anatomy of a Sell-Off," Mr. Westhoff, Mr. Kramer, and V.S. Srinivasan declared: "That loud hissing sound you hear is the air going out of the largest refinancing wave in the history of the mortgage market."

According to the analysts, refinancing exposure in the mortgage market had fallen from 96% to 59% from mid-June through late July, a level they termed the lowest since the fourth quarter of last year.

"The precipitous decline in refinancing exposure has been fueled by both rising rates and a recycling of high coupons into low coupons (e.g. the weighted average coupon of the MBS universe has declined 30 basis points since January to 6.65%)," they said.

The "massive declines" they predicted for MBS speeds in the fall would hit 5.5% and 6.0% coupons especially hard, showing up as a 70% slowdown for the former and a 50% slowdown for the latter.

The analysts noted that 6.0% mortgage rates are still "very attractive" in historical terms and "should support a fairly vigorous secondary housing market. Nevertheless, the fact that we have been below that mark for seven consecutive months suggests that there is very limited residual financing demand above that level."

In other prepayment-related news, Nomura Securities International recently looked at MBS backed by alternative-A mortgage loans and found that they still offer prepayment advantages to investors, but to a lesser extent than in the past.

Alt-A loans show "greater resistance" to prepayments in the first nine to 12 months after their origination, said Nomura analyst Mark Adelson in a report titled "A Journey to the Alt-A Zone."

Mr. Adelson said the prepayment advantage of such loans used to be greater than it is today, but "the increasing efficiency of the primary mortgage market and the encroachment by the GSEs into the sector have caused the advantage to erode somewhat. Nonetheless, it persists for nearly a year following origination and, especially in an environment of falling interest rates, can create value for investors."

The future of the alt-A sector - which in 2002 represented only $54.6 billion in issuance volume vs. total MBS issuance of over $1.5 trillion, according to Nomura - is clouded by the blurring of the distinction between conforming mortgage loans and alt-A loans, Mr. Adelson said.

However, the "relatively new practice of segmenting alt-A loan pools into groups that feature specific loan attributes offers investors the opportunity to fine-tune their strategy in using alt-A MBS to moderate prepayment risk in their portfolios," he concluded.

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