Prepayments Fall Across the Board - But only for Sub 6% Loan Cohorts

Prepayment rates for agency mortgage-backed securities fell across the board for coupons at or below the 6.0% level in the August reporting period while holding steady or rising somewhat among higher coupons.

Writing in the Bear Stearns Prepayment Commentary, analysts Dale Westhoff and Bruce Kramer said percentage declines in constant prepayment rates ranged from 25% to 35% for new cohorts of 5.0% and 5.5% coupons for both conventional MBS and Ginnie Maes.

While acknowledging a few surprises among superpremiums in the report, the analysts said "all signs point toward a sharp slowdown across all coupons and vintages in the September reporting period."

Although pipeline issues may keep speeds on some older cohorts "slightly elevated," the Bear Stearns analysts said they "expect the MBS universe to enter its new prepayment regime starting with next month's report."

Speeds of Freddie Mac MBS were once again consistently faster than those of comparable Fannie Maes, but the gap had narrowed and should close by the end of the year, the analysts predicted.

In another recent publication, Bear Stearns analysts forecast that most of the big drop-off in MBS speeds that should flow from the recent surge in interest rates is likely to occur in the next three months (by the November reporting period).

Writing in the September issue of Short-Term Prepayment Estimates, analysts Westhoff, Kramer and V. S. Srinivasan noted that some observers have argued for a longer period of declining speeds on the grounds that originators won't be able to clear their pipelines rapidly in the wake of record volumes.

But they rejected that argument.

"We have found that capacity issues have increased the lag between application and prepayments only by several weeks," the analysts said. "Therefore, we expect originators to clear any backlog in their pipelines very quickly and prepayments to reflect this process over the next three months."

The Bear Stearns analysts said MBS refinancing exposure had fallen to approximately 40% as of Aug. 21, bringing uncertainty to the market.

"As the massive refinancing wave came to an abrupt end, the MBS market became defined by extreme volatility and diminished liquidity," they said. However, the analysts said they expect the market to enter a "stable prepayment environment" over the next three months. "From a macro perspective, the economy has reached a transition point where the baton must be passed from the consumer to business," the trio of analysts said. "While the housing sector continues to show no signs of contraction ... the cash infusion to consumers afforded by the refinancing engine will be shut down by the end of the summer."

However, there should be a six-month "window of spending" from loans closing this summer "before the cash-out effect is severely diminished," they predicted.

In another prepayment commentary following the release of the August report, Rich O'Connell of RBS Capital forecast that recent-vintage 5.5s and 6.0s will continue to slow "dramatically," while 6.5s will remain at constant prepayment rates above 60 as long as they remain "solidly" in the money.

"Older premiums pose a challenge, as there are many arguments on both sides: the 'surge' effect is rapidly diminishing (we are noticing far fewer mortgage commercials on television), the refi index is now below 2000, and the continued high speeds in September could be attributed to delays in closing older mortgages with stale docs," Mr. O'Connell said.

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