With mortgage rates increasing, extension risk is once again in the forefront of MBS investors' minds, said Citigroup Global Markets analysts. A way to gain extension protection is to purchase collateral with nonstandard characteristics, such as a high LTV or a low FICO score. In the past, loans with these characteristics were seen as credit impaired and associated with slower speeds. But since the GSEs began releasing pool-level LTV and FICO data, the market started believing that "credit-impaired" collateral could provide extension protection in certain cases.
The firm's analysis supports the extension protection properties of high-LTV and low-FICO collateral. The researchers focused on the interaction between FICO and LTV, and on how these characteristics seem to magnify each other's influence on out-of-the money speeds. The main thing to takeaway from this study is that both high LTV and low FICO lead to faster discount speeds, specifically in strong housing markets, and that these two together offer better extension protection than each does apart. In the article, analysts refer to pools with a FICO below 700 as low-FICO pools, and to pools with a FICO above 700 as high-FICO pools. Pools with the original LTV above 80% are referred to as high-LTV pools, and pools with the original LTV below 80% as low-LTV pools.