Prepayment Rates Starting to Creep Up Again

Prepayment rates for Fannie Mae and Freddie Mac mortgage-backed securities recorded "modest gains" in September in coupons below 6.5% and "modest declines" in higher coupons, according to Bear Stearns.

Analyst Dale Westhoff said the speeds of new Fannie Mae 6.0% coupons increased by a constant prepayment rate of nearly 4 CPR, but that speed-ups in other coupons fell short of expectations.

Mr. Westhoff attributed this to "the significant flattening of the yield curve from April to August," which he said reduced the fixed-rate to adjustable-rate refinancing incentive by almost 25 basis points, and to limited news coverage of the recent decline in mortgage rates.

"The biggest surprise in today's numbers was the decline in prepayments in higher coupons in the face of a significant rally in mortgage rates," Mr. Westhoff said of the statistics for the September reporting period.

The analyst noted that 30-year mortgage rates have rallied almost 35 bps over the last two reporting periods with "very little" prepayment response. "Across the entire coupon spectrum, speeds today are lower than they were in June 2004, while mortgage rates are at least 20 bps lower than for the June reporting period," Mr. Westhoff reported.

Regarding the gap between Fannie Mae and Freddie Mac prepayment rates, the Bear Stearns analyst said Freddie Mac MBS speeds continue to lag behind Fannie Mae's. The "most notable" lag was in vintage 2003 6.0% coupons, he said, where Freddie Mac speeds fell 7.5 CPR short of Fannie Mae's.

Mr. Westhoff cited several factors that he said should cause Fannie MBS speeds to exceed Freddie's: a differential of 5 basis points in weighted average coupon, a larger average loan size in Fannie Mae pools, and a higher concentration of California loans.

However, he went on to say that the existing difference in speeds "cannot be fully explained" by observable loan attributes.

"Perhaps servicer controls put in place in 2003 by [Freddie Mac] are contributing to this trend," Mr. Westhoff speculated. "We also note that Countrywide (the largest servicer aligned with [Fannie Mae] and slowest servicer during the 2003 refinancing wave) has become the fastest servicer in today's higher interest rate, less refinance-dominated mortgage environment."

As for Ginnie Mae MBS speeds, those of vintage 2003 and 2004 issues were "generally flat to modestly faster" in September, Bear Stearns reported. Vintage 2003 Ginnie Mae coupons of 5.0%, 5.5% and 6.0% paid 17, 24 and 33 CPR, respectively.

"These issues continue to run 3 to 7 CPR faster than their conventional counterparts," Mr. Westhoff said.

Among seasoned Ginnie Mae coupons of 6.0% and higher, most issues slowed 5%-8% in September, according to Bear Stearns.

Commenting on the faster-than-conventional Ginnie Mae speeds in the October Bear Stearns Short-Term Prepayment Estimates, Mr. Westhoff and analyst V. S. Srinivasan said they expect the trend to persist because the rate of serious delinquencies for Ginnie Maes is running "five times higher" than those in the prime sector.

The trend is "accelerated" by the ability of servicers to buy such loans out of Ginnie Mae MBS, they said.

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