Interest in prepayment-protected paper has increased with the drop in mortgage rates, which  has also led to increasing pay-ups for this kind of paper.

A cheap alternative to HLBs that investors should consider, Deutsche analysts said, is 80-90 LTV bonds. They noted that pay-ups currently are on the order of one to two ticks in 5.5s and 6s. By comparison, 5.5% loan balance paper is around 16 ticks for LLB, 12 ticks for MLB and 8 ticks for HLB and for 6%s, 22 ticks for LLB, 16 ticks for MLB and 12 ticks for HLB.

Analysts said that 80-90 LTV paper has shown slower prepayment speeds as a result of the tight lending standards and the high guarantee fees the GSEs charge for high loan-to-value loans.

They noted that currently the prepay protection on 80-90 LTVs is just marginally lower than HLB. In December, for example, 80-90 LTV 6s increased 5.7 CPR versus about 5.1 CPR for HLB.

Deutsche believes that the prepayment difference between 80-90 LTV and loan balance paper is likely to compress as the high LTVs have essentially been priced out of conventionals, but GNMAs are not an attractive alternative yet. These securities will likely be further impacted as housing prices continue to decline, as is expected for some time yet, which further inhibits their ability to refinance.

After adjusting their model to minimize the bias shown to loan balance paper, analysts calculated that 6s have a pickup of 8 basis points, while 5.5s have a five basis point pick.

"In isolation, the 80-90 LTV paper takes only a month or two to earn its payup back through the carry differential," Deutsche said.

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