With the August prepayment report due out by the end of next week, investors are already asking about how slow prepay speeds can get.
Kevin Jackson, vice president at RBC Dain Rauscher said that this would depend on the rate of home price appreciation and housing turnover. “We think it is plausible in the current environment to run speeds that imply a moderate home price path over the next year and somewhat faster after that,” said Jackson. “This is as an important time as any to run mortgage cash flows using the most appropriate vectors.”
He stated that when rates increased back in 1994, 92’ and 93’ origination loans prepaid at 3.0% CPR, on average between 1994 and 1996.These loans prepaid at 9.1% CPR between 1999 and 2001.Jackson added that similar speeds were observed on 97’ and 98’ originations. These loans prepaid at 5.4% CPR, on average, between 1999 and 2000. They sped up to an average speed of 12.5% CPR in 2001.
Jackson said that speeds on new origination discounts could begin slow and then speed up as cash flows season. The seasoning of the cash flows depends on home price appreciation and the state of the economy.
Meanwhile, Citigroup expects August prepayments to decline by only 15%. Analysts said that this implies that the market would witness aggregate conventional speeds of about 52% CPR in August.
With rates over 120 basis points above the June lows and the Mortgage Bankers Association (MBA) Refinancing Index approximately 80% below its recent peak, prepayments should slow down over the next few months. But Citigroup expects aggregate speeds to drop more slowly than the number of mortgage applications.
These expectations are derived from historical observations during selloffs. For instance, at the end of the refi waves of 2001 and 2002, speeds dropped less than the MBA Conventional Fixed-Rate Index, said Citigroup. The firm attributes this phenomenon to longer lags between applications and closings that usually lead to speeds staying at elevated levels longer.Aside from this, pipeline fallout tends to diminish during periods of rising mortgage rates, leading to speeds higher than the MBA Refinancing Index may imply..
Citigroup said that the September prepayment report would probably show aggregate speeds coming in at about 40% CPR. This projection is a bit faster compared to what the MBA-Index-based model suggests. But analysts believe that the MBA model might be underestimating aggregate September speeds due to weaker fallout and more fixed-to-ARM refinancings.