As Fannie Mae and Ginnie Mae released reports on their prepayment data last week, many market participants were surprised by how muted the declines in prepayment speeds were - and especially surprised by a reported increase in speeds for some high premiums.
According to prepayment specialist Warren Xia, vice president and senior analyst at Banc of America Securities, Fannie Mae 30-year discount (6% and 6.5%) prepayments increased sharply in June, reflecting the seasonal strength in home sales. Speeds of Fannie Mae premium coupons, however, were insensitive to the rise in mortgage rates.
"The reasons for the muted response of premiums were twofold," Xia said. "First, the housing turnover component, evidenced by the strong discount speeds, was strong. Secondly, the additional two business days in the June prepayment reporting period helped to dampen any sharp speed declines.
"Going forward, we expect premium speeds to decline sharply in July, reflecting the rapid rise in mortgage commitment rates in June."
In fact, virtually everyone on Wall Street agrees that prepayments on mortgage-backed securities will slow over the next six months.
However, there appears to be some debate over the extent of the slowdown.
"Based on most Wall Street dealer projections, speeds are expected to fall an additional 20% to 50%, especially in the cuspy coupons," said Sudha Garg, a manager at Freddie Mac who digested the prepayment analyses of several Wall Street dealer-brokers.
According to her research, Morgan Stanley Dean Witter Inc. and Goldman, Sachs & Co. expect speeds to fall at the high end of the range because burnout continues to dampen prepayment speeds as mortgage rates remain persistent at staying below 7%.
Lehman Brothers, however, is expecting a less severe decline in speeds. Lehman noted that the Mortgage Bankers Association's index remains unusually high given the current level of mortgage rates, Garg noted, adding that the MBA index is higher today than it was in August 1997 when mortgage rates were comparable.
Lehman attributed the higher level of refis to leftover build-up in refinancing expertise from the recent refi boom and to a surge in the number of cash-out refinancings, brought on by the rise in home prices since late 1997.
Mortgage experts are quick to point out, however, that the prepayment speeds in the current reports were driven mainly by where rates were in April and early May, when mortgage rates were approximately 75 basis points lower than today.
"It is really unsurprising that we didn't see any slowdowns in premiums," said Art Frank, the head of mortgage research at Nomura Securities. "The only real surprise were the very high premiums. But next month premiums will slow because of the rate moves over the last two months. July and August are traditionally the seasonal peaks for housing turnover because people seek to move in between school years."
The continued strong level of housing turnover has led to strong home sales, with people trading to bigger homes and larger mortgages.
"As high as rates are, they are still lower than where they were two or three years ago," said an MBS player. "People have some equity in their house, and their payments are probably higher - but still relatively low compared to four or five years ago, or even 1996." - AT/ES