The June prepayment report, released last Tuesday, showed prepayments on FNMA 30-year 5.5s increased to an "eye-popping" 42 CPR, which is a 159% rise from May, said analysts from Credit Suisse First Boston.
Recently originated 30-year conventional 5.5s set the prepayment pace for the June report. Speeds increased sharply in 2002 and 2003 vintages, said Bear Stearns in a report released Tuesday morning.
Bear said that in the conventional 30-year 2003 vintage (with $273 billion outstanding) Fannie 5.5s surged to 20.8 CPR from 7.2 CPR. Meanwhile, the smaller and more seasoned 2002 vintage (with $141 billion outstanding and a WAC nine basis points higher) jumped to 42.4 CPR from 18.6 CPR.
"This was clearly the sweet spot' of the refinancing pipeline as these borrowers were the easiest and most lucrative to refinance," Bear wrote. "With a WALA of eight, the jump in 2002 5.5s confirms the shortening of the refinancing aging ramp in the current wave."
Bear Stearns noted that the 5.0% coupon was unresponsive in this report, going up to 3.8 CPR from 1.3 CPR in May. Analysts said that they expect to see a much larger response emerging in this coupon
in next month's report. Aside from these, conventional 30-year 6.0s showed considerable gains as well. This was particularly apparent in 2002 vintage FNMA, which increased to 60.4 CPR from 46.2 CPR.
In a Merrill Lynch report released last Wednesday, the firm said that the higher-than-expected speeds on 5.5s is probably related to a number of factors, such as the improved systems and capacity over the past one to two years, which have likely made processing time slightly faster. Merrill also noted that while speeds on 5.5s were faster than expected for the June prepayment report, it remains well below projections compared to the next reporting period.
Merrill also noted that although there was a sharp jump in 5.5s, high premium speeds had actually dipped this month. For instance, 2000-2001 vintage 7s and 7.5s dropped by roughly 1 CPR while more seasoned vintages fell by 4 to 5 CPR.
"We believe that this is due to the focus of mortgage bankers on refinancing the higher balance 5.5s and reducing the attention paid to the more seasoned premiums, which can still be refinanced later even if rates rise," wrote analysts. They added that this probably will not be a long-term trend, and it is expected to reverse somewhat over time.
The arguments presented basically look at the high speeds on 5.5s in terms of lags. Merrill said that in general, processing time is quicker, especially when it comes to lower coupons, during times of high refinancing activity. Investors should be cautious about extrapolating this one-month acceleration of speeds on 5.5s to all future months.
However, Merrill does not believe that the current speeds can be attributed entirely to lags. Some of the acceleration is likely due to the fact that 5.5s of 2002 are probably among the most efficient refinancers. These borrowers were the first to obtain the low rate when it was first available, and they were probably equally efficient at taking advantage of the new low rates, which were available in May-June.
Other analysts said that the strong refinancing response seen in this sector is because the borrowers, who had average balances of $160,000 to $167,000, were faced with a first-time opportunity to refinance during this reporting period.
Analysts said at and above the 6.5% coupon level, conventional 30-year issues exhibited a muted response in June's report. Meanwhile, 1998 and later vintages of the 6.5% coupon went up modestly and the 1993 vintage decreased by 3 CPR. Higher up in the coupon stack, most issues were flat to slightly slower.
Most notable in the June report was a divergence in the response between lower coupon (6.0s and lower) and higher coupon (6.5s and higher) issues, Bear analysts said. The lower coupons, particularly 5.5s, witnessed a significant jump in speeds due to the first-time opportunity to refinance. For 6.5s and higher, the average lag rate for this report was not sufficient to push speeds considerably higher. Since June's report corresponds to a mortgage rate of roughly 5.5% and MBA Refi Index results ranging from 7500 to 8000, Bear expects to see additional increases happen in next month's report as a response to a record low in mortgage rates of 5.25% and a 10,000 peak in the Refi Index. Furthermore, analysts expect more seasoned and higher coupon issues to respond to those rates even though they looked relatively unresponsive in the current report.
Meanwhile, CSFB expects peak prepayments in the July report in most cohorts, flattening in August, and a slight drop in September. The firm is revising its expectations for the July report - bringing its estimates closer to the expected speeds for August on 30-year 5.5s and 15-year 5s. Slight upward revisions are predicted in 30-year 5s and 15-year 4.5s. JPMorgan Securities predicts that overall speeds to have a 10% pickup in July with 2002 5.5s accelerating by almost 20% to 25%. Speeds in August should be flat to July while the recent selloff is probably going to have an impact on September speeds.
Merrill Lynch said that regardless of the coming peak in conventional 5.5s, prepayments are headed downward. With current coupon yields now at 4.90%, and the mortgage rate probably around 5.55% (reported last Wednesday), the firm expects speeds to fall back into the mid-30s by the fall.
In the GNMA sector, speeds in the lower coupons generally kept abreast with their conventional counterparts, with 5.5s of 2003 rising nearly 13 CPR (20.4 from 7.5), and 2002 5.5s adding nearly 17 CPR (34.4 from 16.8). In the higher coupons (those above the 6.5% coupon), most GNMA speeds were flat to slightly higher.