The big issue in the MBS market last week was the implications for the future of cleanup calls on Fannie Mae mortgage securities (see story p.13). On the previous Friday, the market was caught off guard by the surge in March prepayment speeds for Fannie Mae seasoned super premiums. For instance, 1987 8s jumped to 70% CPR from 37% CPR; and 1991 and 1987 8.5s rose to 77% CPR from the 25-40% CPR area.
Unlike Freddie Mac MBS, Fannie Mae's mortgage securities program includes various provisions for calling its mortgage-backed securities. Basically, the rules for a cleanup calls are as follows:
*Pools with a factor below 10% issued before May 1, 1993 and are not contained in any Megas issued after December 1993 and before March 2002, or in REMICs or Strips.
*Pools with a factor of less than 1% issued before May 1, 1993 and are contained in Mega Pools issued after December 1993 and before March 2002, or in REMICs or Strips.
*Pools which have only one loan remaining and have a factor less than 10%, but greater than 1% and are contained in Strips issued prior to the end of 1993 or issued after March 1, 2002 and not contained in any Strip.
The GSE said that until recently, it didn't have the capability to deal with cleanup calls. It was less of an issue until over the last year when rapid prepayments on MBS reduced outstanding balances to very small amounts. The number of pools became significant enough that Fannie Mae began to develop a system to exercise their call option it said. Fannie said that the total amount of cleanup calls exercised in March was about $1.5 billion. The average outstanding pool balance on the MBS that were called was approximately $59,000 versus an average outstanding pool balance of around $3.3 million on currently outstanding pools. Fannie Mae did not call any adjustable rate mortgages, however, they could be called in the future.
In a detailed report issued last week, Bear Stearns broke down the MBS called, highlighted below, and discussed the implications of the cleanups for the future.
*Fannie Mae called 61% of the 30-year MBS pools with a total outstanding amount of $1.23 billion that were eligible to be called in March;
*The total balance of 30-year FNMA MBS that remains eligible to be called during or after April is $807 million.
*In the 15-year sector, 49% or $142 million of eligible pools were called in March. Currently, $170 million of 15-year MBS remain exposed to this call option.
*No ARMs were called though they are eligible.
Implications for the future
At this time, the Street is working to incorporate the potential for cleanup calls in their models. The sector at highest risk for call is nearly every 30-year vintage prior to 1987 and for 11% and higher coupons, according to Bear. In addition, beginning last month, FNMA implemented the following change to its cleanup calls: MBS pools will be subject to the 1% factor or 1 loan rule, the same as REMICs. As a result, says Bear Stearns, investors will need to become sensitive to pool size as well as loan size. Based on their analysis, the breakeven point where the risk of exercise of a 1% factor and 1 loan call is equal is a pool size of $15,000,000.
No ARMs were impacted by the call, however, they can be called in the same manner as the fixed rate program. Bear Stearns believes the risk is not great given the small size of the ARM universe and the lower dollar prices on ARMs currently. UBS Warburg, on the other hand, expects heavy call activity on ARMs in the months ahead. In addition, they anticipate increased REMIC activity as investors move to convert 10% calls into 1% calls.
For more information on Fannie Mae's cleanup call provisions, see their website at: www.fanniemae.com.
Prepayment speeds on Fannies were in-line with expectations with the exception of the super premiums. Speed increases were confined to unseasoned 6s through 7s with other coupons and vintages little changed to slower. It was a fairly similar situation for Ginnie Maes.
Looking to April, analysts expect prepayments to hold within a small plus and minus range. Lehman is currently projecting declines of about 10-15% in 6.5s through 8s. In May, speeds are projected to slow 20-25% from April's levels in 6.5s and 7s, and 10-15% for 7.5s and 8s. As a result, by May, Lehman predicts 2001 6.5s to prepay at 8% CPR from 12% CPR currently; 7s at 19% CPR from 27% CPR; and 2000 7.5s at 46% CPR versus 59% CPR in March.
enthused about MBS
Flows last week started off busy with 48-hour notification looming on 30-year conventionals. It slowed, however, as rolls reached near-fail levels. In addition, the strong first quarter performance and prospects that future gains may be harder to achieve given the drop in volatility tempered investor interest.
In addition, some analysts on the Street are recommending investors take some chips off the table. For example, Salomon Smith Barney recently reduced their overweight recommendation from a full to a modest one. While the technical picture remains favorable, they note that MBS implied vol OASs versus agencies are at their narrow ends of recent trading ranges. In addition, they believe that the downward trend in implied vols has run its course for now. Lehman is holding with neutral believing the sector needs to cheapen up. And Merrill Lynch announced that it was reducing its overweight in MBS to 37% from 40%. One reason cited was the strong performance of the sector.
They still expect the sector to outperform other sectors going forward, but note that the GSEs have less of an incentive to buy MBS with funding costs higher. Also, one strong point that has favored the 30-year sector has been its excellent carry. This looks like it will be diminishing in the months ahead. According to UBS Warburg, they "expect rolls to remain slightly special over the next few months, but not nearly as much as they've been." They believe the 15-year roll could do better and suggest moving from 30- into 15-year collateral. Investors are cautioned to hedge out the yield curve risk though if they do this.
Spreads were one to two basis points tighter in currents, and wider by a similar amount in higher coupons over the week.
The Mortgage Bankers Association announced a slight decline in mortgage applications for the week ending April 5. This was expected despite the fact that rates have dropped. Both the Refi and Purchase Index fell nearly 5% to 1214 and 333, respectively. Most of the decline in refi applications was from a sharper decline in FHA/VA applications. The Government Refi Index was down 14% to 682 while the Conventional Refi Index was off 4% to 1315.