Traditional call protection sectors such as loan balance, high LTV, and certain geographic concentrations are fully valued at this time, according to Credit Suisse analysts.

An alternative analysts suggested in a report is pools with high cash-out concentrations. Based on historical data, they noted that cash-out loans tend to prepay more slowly than purchase counterparts when in the money.

Specifically, they recommended high refi share 30-year 5.5s pools as a cheap source of convexity at an indicated pay-up of two ticks over TBA that results in a breakeven period of just two months.

In the report, analysts noted that cash-out borrowers typically display less interest rate sensitivity and at times will actually refinance into a higher rate loan. In this case, these borrowers are likely consolidating their other higher cost debt into the mortgage loan
— which also has tax benefits for the homeowner through the interest deduction.

Credit Suisse also pointed out as well that typically higher cash-out shares are negatively correlated to FICO scores. As such, in periods of home price growth borrowers will tend to cash-out equity in their homes, while in an environment such as now with home price erosion and comparably lesser sensitivity to (currently low) interest rate levels makes then less like to refinance, they said.

The overall refinancing share can be used as a proxy for identifying pools with high cash-out concentration, analysts said. Based on Freddie Mac's loan level data, cash-out loan comprise around 70%, 65% and 50% of the total refi-loan population for 5.5-6.0 coupons from 2006-2008 vintages, respectively.

Credit Suisse added that 15-year refinance pools also offer a similar convexity advantage versus purchase counterparts.


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