MBS Investors Have This to Fear from Low Interest Rates
Investors in residential mortgage-backed securities (MBS) have a new wrinkle to deal with, at least in the near term. Borrowers are taking advantage of lower rates to refinance their mortgages. That means faster prepayment speeds this summer.
Bloomberg News reported that June speeds should come in flat or even slightly lower due to a reduced day count compared to May. But the August report should show prepayments to be about 20% higher than current levels, says Bloomberg, citing a recent report by JPMorgan MBS strategists.
Although MBS analysts from Bank of America expect a 10% decline in conventional speeds this month led by 2018-vintage loans, also due in part to a two-day reduction in day count, they similarly expect a rebound next month.
One of the main variables that MBS traders must forecast to properly value their investment is the speed at which the underlying home loans will be paid off. Speeds are measured by Conditional Prepayment Rates, a number which gives the annualized percentage of the existing mortgage pool expected to prepay.
It’s in the more recent mortgages, specifically the 2018 and 2019 vintage 30-year 3.5% and 4% coupons, where most of the prepayment risk is considered to be concentrated, Bloomberg reports. These mortgages display many ‘red flags’ that point to borrowers having faster response times to lower rates, such as high FICO scores and large loan sizes.
For example, Bloomberg reports that Nomura’s MBS strategist team predicts that while Fannie Mae 30-year 3.5% and 4% speeds will tick downward in June, they will ramp back up 18% and 17% higher from current levels by the end of August. Both coupons’ speeds will likely be driven by their 2018 and 2019 vintages.
Bloomberg notes that investors could prepare for this by using specified pools, which are designed to protect mortgage portfolios from a spike in refinancings. A sustained rate rally through the summer months may help those securities maintain or even increase in price.
For comments, questions or concerns, please contact Paul Bubny
- ◦Economy
- ◦Financing
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