With home prices still appreciating at record levels, analysts report that the differences in growth rates on an individual state level are disguised, and in turn, artificially inflating prepayment speeds.
Credit Suisse First Boston researchers note that by looking at the national average, the market has failed to delineate the varying impact of home prices in the different regions. "Strong home price growth has elevated observed prepayment speeds across a range of refinancing incentive levels," analysts concluded.
Analysts studied prepayment trends during the summer of 2003 and 2004 while looking at the market's current prepayment profile of August 2005. These three snapshots represent the starting, transitory and current periods in terms of prepayments, allowing analysts to compare and contrast the shift in profiles between two refinance waves and the latest period marked by modest refinance activity. They arrived at similar conclusions with 2003 and 2004 vintages, although findings are presented using the 2003 vintage.
These diverging home price trends have resulted in "diluting the value of call protection historically provided by pools with exposure to states such as Florida and Arizona whilst imparting extension protection in pools with high California concentration," analysts stated.
Analysts also explained the effect of strong price growth on geography, asserting that speeds on discount out-of-the-money pools are directly correlated with robust home price appreciation. Additionally, premium coupon speeds have risen in states with strong home price growth like Arizona, Florida and Nevada, diverging from trends observed in 2003. For instance, pools with high Arizona and Nevada concentrations prepay faster than the national average, which was not the case in 2003. Florida, meanwhile, is now close to the national average and New York remains below.
All else being equal, investors looking for call protection should favor the states with the lowest relative home price appreciation pools while those looking for extension protection should move into pools with the highest relative home price growth, according to analysts.
Cash-out refinancings could also explain the differences between states. "Robust home price appreciation has fueled cash-out refinancing, potentially becoming the marginal driver of speeds in the relatively contained prepayment environment today," analysts added. Cash-out activity could explain the shifting prepayment profiles across states, boosting speeds in high home price growth areas while dampening response in slower home price growth states.
For instance, a rise in cash-outs could offset some dampened refinance activity resulting from Florida's 0.35% documentary stamp tax on mortgages. But New York's premium coupon speeds are slowed by a tax of up to 1% of the mortgage amount.
In terms of relative value, CSFB stated that the effects of cash-out activity and home price appreciation are seen in both 30-year and 15-year collateral, but are somewhat muted in 15s, because 15-year borrowers would rather accumulate, rather than extract, their home equity. Another reason for the reduced effect of home price growth is the fact that 15-year loans typically have lower loan balances.
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