Rates May Be Rising, But Prepay Speeds Have Yet to Slow Down

April brought another jump in the prepayment rates for Fannie Mae mortgage-backed securities, especially among 2003 vintage 5.0% and 5.5% coupons.

The constant prepayment rates of Fannie Mae 5.0s and 5.5s increased by over 50%, from 10.6 CPR and 24.4 CPR, respectively, in March to 16.0 CPR and 35.4 CPR in April, analysts Dale Westhoff and Bruce Kramer reported in the Bear Stearns Prepayment Commentary.

Speed-ups among higher coupons were "much more muted," they said, with 6.0s and 6.5s increasing by 15% and 5%, respectively.

The analysts attributed the "amplified response" in lower coupons to "the heavy population of large loan balances ($155K-$175K), high FICO scores (718-725), and prior refinancers (approximately 75% of the borrowers)."

Speeds of 2003 and 2004 vintage Freddie Mac MBS were similar to or slightly below those of comparable Fannie Maes, which the Bear Stearns analysts said may stem from Freddie Mac's efforts to return its MBS speeds to market averages.

For example, the speed of 2003 vintage Freddie Mac 5.5s stood at 34.6 CPR in April, while comparable Fannie Mae coupons registered a 35.3 CPR. The speed of 2004 vintage Freddie Mac 6.0s was 22.9 CPR, compared with 23.8 CPR for comparable Fannie Mae securities.

"With minimal spillover effects expected from an origination pipeline with excess capacity, speeds across the entire coupon stack should reverse course in May as the effects of the 80-plus basis point sell-off in mortgage rates since March begins to hit the numbers in May, June and July," Messrs. Westhoff and Kramer said.

Regarding Freddie Mac's efforts to return its MBS speeds to market averages, the analysts had more to say in the May issue of the Bear Stearns Short-Term Prepayment Estimates, where they reported that the scandal-marred government-sponsored enterprise has apparently been successful in boosting its MBS market share.

Messrs. Westhoff and Kramer, along with analyst V. S. Srinivasan, said Freddie Mac's overall market share had risen to 39% as of March.

"This is still well below their historical share of between 45% and 50%, but a significant improvement over their 32% share in 2003," the analysts said.

One beneficial development for Freddie Mac has been a narrowing of the price spread between its MBS and Fannie Mae's as speeds for the two government-sponsored enterprises' securities have converged, they said.

"Although this is a positive development, we believe the largest drivers of this trend have been rising rates, lower dollar prices and slower overall prepayments rather than any specific action taken by [Freddie Mac]," the Bear Stearns analysts said.

Freddie Mac announced two strategies last year to address the performance of its MBS, the analysts noted.

One was the adoption of contractual incentives based on a seller's prepayment experience, such as charging a higher guarantee fee if a seller's prepayment rates are faster than the overall average.

The other was a commitment to return loan characteristics and market share to levels closer to their historical norms. The analysts said Freddie is apparently trying to be more aggressive in pricing alternative-A loans that have better prepayment characteristics and to be more competitive in setting G-fees.

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