Prepayment speeds on 30-year FNMAs in January fell more than 20% from December's levels, versus consensus expectations of 15% to 16%. The decline was fairly uniform across both discounts and premiums.
In comments from JPMorgan Securities, analysts stated that the drop in discount speeds cannot be totally explained by current seasonal patterns. They believe that declines in cash-out refinancing activity and higher hybrid ARM rates have also contributed to the pressure on lower coupon speeds.
Bear Stearns senior managing director Dale Westhoff said the slower speeds in discounts during January are not necessarily indicative of a slowing housing market. He said "adjusted for seasoning and relative coupon, they are consistent with speeds in January 2005."
He warned, however, that the 6 CPR (96 PSA) print in 2003 4.5s is a reminder of the extension risk that looms over the fixed-rate MBS sector. While prepayment speeds on mortgages that are 25 to 75 basis points out-of-the-money are consistent with those of a year ago, speeds on deep discounts show the embedded extension risk in the market, Westhoff said. For example, the 2003 4.5 cohort speed was the slowest since April 2004. He believes if the housing market remains relatively strong, speeds on the deep discount sector are likely to converge to their historical norms due to reduced cash-out refinance opportunities.
Home equity extraction to drop
Freddie Mac economists expect home equity extraction to fall to about $117 billion in 2006 from an estimated $243 billion in 2005 due to lower refinance activity and slower house price appreciation (see story below).
FHLMC Gold speeds declined more than FNMAs at over 25%. CPRs on FHLMC Golds remain slightly lower than FNMA counterparts, but the differential is narrowing.
Also of note is the further convergence of 30- and 15-year speeds. JPMorgan analysts note the difference between FNMA 5s and Dwarf 4.5s are currently within 1% CPR, while FNMA 5.5s and Dwarf 5s are within 2% CPR. The researchers expect this trend to continue in the next month, and believe it could be due to the softening housing market, which would likely impact 30-year speeds more.
According to Credit Suisse analysts, January paydowns totaled about $33.1 billion, down 18% from December. They report fixed-rate net issuance at $26.8 billion, up from $20.5 billion in the previous month. Also, 30-year net issuance totaled $29.2 billion, while 15-year net issuance was negative-$3.5 billion.
GNMA speeds also slowed more than expected. However, percentage declines were less than FNMAs at around 15% to 20% for most coupons and vintages. Speeds remain faster than conventional counterparts.
Prepayment outlook
Looking ahead to February, expectations are for speeds to be modestly higher. The Refinance Index was 22% higher in January, averaging 1666 compared to 1371 in the previous month. Partially offsetting the expected rise is one less collection day in February -19 days - compared to January's 20 days. The March outlook has speeds increasing over 20% on improving seasonals and an increase in the day count to 23 days.
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