January prepayment reports highlighted record speeds with some cohorts prepaying at 70 plus CPR. Coming off a year that saw the biggest refinancing wave ever, it's worth taking a look into the increasing efficiency with which people are exercising the refi option, which some people say may be responsible for the remarkable numbers.
According to a recent report by UBS Warburg, "an interesting surprise" happened early last year when the time lag between loan application and closing was shortened to less than a month, causing fast prepays to arrive a month earlier than anticipated. The report said that this is a reflection of improved refinancing/origination efficiency apparent in new production, but not in seasoned vintages.
"One of the characteristics of last year was that new production prepaid much more aggressively than seasoned vintages," said Glenn Boyd, an associate director from the mortgage strategy group at UBS.
The changing characteristics of prepayments were associated with two major points: burn-out, or the proportion of the pool that has already prepaid, and streamlined refinancings.
The disparity due to burn-out is historically worth between 10 to 15 CPR in terms of the fastest-paying cohorts. However, the differences in speeds that were seen last year ranged between 20 and 25 CPR, which were difficult to attribute try burn-out alone.
The belief is that new production was being refinanced in a much more streamlined fashion, for example, through streamlined refis. This meant it was easier for homeowners with only one- or two- year old loans to prepay, and therefore these types of loans would prepay faster.
Analysts said that the differences between the speeds of new and seasoned production would not last.
UBS said that conversations with lenders reveal that they plan to actively pursue a strategy that would allow the streamlining process to include seasoned production, which would likely cause seasoned speeds to converge towards new production in the next refi wave, with the assumption that it happens in the next two years to three years.
"It's very likely that programs would be developed that would allow more seasoned borrowers to refinance very easily and quickly," said UBS's Boyd.
David Montano, head of mortgage research at Credit Suisse First Boston, noted that the convergence between new and seasoned speeds would most probably happen when refinancings slow down.
While newer loans are basically reacting to refinancing incentive, seasoned paper has experienced burn-out (and are generally far smaller loan balances). Aside from this, seasoned paper has a much larger equity component that could motivate homeowners to refinance even without the interest-rate incentive. Thus seasoned speeds would not slow down as fast as new production would, allowing the two to converge.
Shorter lags due
to refi efficiency
The increased refinancing efficiency allows for much shorter lags compared to 1993 (it currently takes about four weeks where it took about eight weeks in 1993). However, the actual costs included in refinancing have only gone down marginally.
According to CSFB (analysts at the bank compared prepayments from December 1993 and November 2001 that have similar incentives), sensitivity in 2001 prepayments was similar to that of 1993, after adjusting to increased loan balances. Analysts said that as loan limits go up, negative selection and prepayment differences between 30-years and 15-years will also increase. They also said that the impact of technology has had more of an effect on lags than rate sensitivity.
"Homeowners are responding to economic incentive at the same rate, but they can do it a little faster now than seven years ago," said Montano.
Where do speeds
go from here?
Though increased efficiency was definitely a factor in the considerably fast speeds seen in the January prepayment report - which reflected prepayment activity in December - analysts said that there were other factors that contributed to the accelerated prepayment numbers. Some of the prepayment activity may be attributed to those who locked in mortgage rates when they hit an all-time low in Oct. 2001.
Even if the peak of the refinancing boom happened in December, the general consensus is that the prepayment wave is not yet over, even considering the sharp drop of refinancing activity compared to late last year, which is reflected in the recent steep decline in the MBA Refinancing Index.
As Lehman Brothers said, "... the precipitous decline in the Index does not imply a commensurate decline in prepayment rates. The reason simply is that the large bulge in the borrower population in the 6.5s and 7s causes sharp changes in refinancing activity as these cohorts move in and out of the money. "