Prepay Rates Edge Up on October Rate Drop

The speeds of 30-year Fannie Mae and Freddie Mac mortgage-backed securities rose moderately in October on the heels of a mortgage rate decline of 17 basis points.

According to Bear Stearns analyst Dale Westhoff, the results "show the classic symptoms of burnout: new issues increased more than seasoned issues while lower cuspy coupons were more responsive than higher coupons."

Mr. Westhoff noted that the speeds of 2004 MBS rose by over 20%, while those of earlier vintages increased considerably less. Most of the aggregate prepayment rise is attributable to the speed-up in the 5.5% coupon, he said.

Overall, the refinancing curve continued to flatten out, as coupons of 6.5% and below speeded up moderately and higher coupons slowed somewhat.

"Without a catalyst to unleash a significant refinancing event, the higher coupons are clearly exhibiting more burnout than they have over the last two years," Mr. Westhoff said. "Nevertheless, we feel that if mortgage rates were to enter the 5.60% to 5.40% corridor, exposing the 5.5% coupon, the observed burnout in recent months would be greatly diminished."

Ginnie Mae MBS speeds continued to exceed those of conventionals across the board in October, Mr. Westhoff reported, but with wider gaps in 2003 and 2004 vintages.

The Bear Stearns analyst predicted that the prepayment pattern in the November report will be similar to that of October, with most increases centered in the 5.5% coupon.

Meanwhile, he noted that Freddie Mac speeds continued to be slower than Fannie Mae's nearly across the board in October for 30-year MBS.

"While it is true that [Freddie Mac's] seller distribution has become more diversified since 2003, it does not explain fully the slower speeds across vintages," Mr. Westhoff said. Bear Stearns believes the differences stem from the fact that loans with nonstandard borrower characteristics make up a larger share of Fannie Mae pools than Freddie pools, he said.

If mortgage rates hold steady or rise, Fannie Mae MBS speeds should continue to exceed Freddie Mac's, Mr. Westhoff predicted. But if rates fall to new lows, it should result in a convergence in the agencies' speeds, he said.

In the November issue of the Bear Stearns Short-Term Prepayment Estimates, Mr. Westhoff and analyst V.S. Srinivasan noted that this relationship between Fannie Mae and Freddie Mac speeds is a reversal of the Freddie-faster, Fannie-slower pattern during the 2003 refinancing wave.

The analysts said actions taken by Freddie Mac - such as the adoption of contractual incentives and penalties based on a seller's prepayment experience, and a commitment to return loan characteristics and seller distribution to "more typical" levels - is partly responsible for the reversal. But they opined that "servicer behavior has contributed heavily to this trend."

For example, they pointed to the disparity in the recent prepayment records of Countrywide and Wells Fargo pools, and how closely those differences mirror the ones found between Fannie and Freddie.

Countrywide, Fannie Mae's biggest seller, has been paying much faster in recent months than Wells Fargo, which is Freddie Mac's biggest seller, the analysts reported. Last year, when Freddie Mac MBS speeds were higher, Wells Fargo pools paid much faster.

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