The gaps between prepayment rates in Fannie Mae and Freddie Mac’s mortgage securities remained relatively manageable in the third quarter of this year, according to the Federal Housing Finance Agency.
Three-month conditional prepayment rates for the two government-sponsored enterprises were “reasonably aligned quarter over quarter” based on their comparison to benchmarks in a final rule the FHFA set in line with the establishment of uniform mortgage-backed security operations.
Under these standards, the FHFA generally tries to ensure the differential hasn’t exceeded 2 percentage points for each group or “cohort” of securitized mortgages with the same coupon, maturity, and loan-origination year that exceeds $10 billion in total issuance. For the fastest quartile, or one-fourth of the group with the highest speeds, the gap can’t be larger than 5 percentage points. Gaps tend to widen at higher speeds, but generally prepayments have been relatively low due to the extraordinary runup in rates this year.
Prepayment speeds, which the FHFA tracks only in the main to-be-announced agency securitization market, generally were below these benchmarks during the quarter. In September, for example, the average, three-month CPR rate across the fastest quartiles of all cohorts listed in the report was nearly 1.89 percentage points.
However, there were some exceptions in higher coupon securitizations.
One quartile in the report, for example, had a divergence greater than 2 percentage points in the third quarter. That quartile, which was the fastest within its cohort, had a 2.2 percentage point differential and the following weighted averages: coupon, 4.68% to 4.72%; and loan age, 49 to 51 months. Other characteristics of that cohort included a 731 to 736 FICO credit score and an average loan size in the $282,000 to $287,000 range. Generally speaking, however, the differential for most quarters listed was below 1 percentage point.
Measures that monitor how interchangeable Fannie and Freddie’s mortgage-backed securities are have drawn more focus since July when the Federal Housing Finance Agency added a new fee to cover additional capital required for UMBS that some fear could upset the balance in the long-term.
The capital charge is tied to the responsibility each GSE has to step in for the other if a payment on securities fails to be made, which groups like the Structured Finance Association and the Urban Institute worry could send a signal to investors that differences do exist between the two counterparties and the securities aren’t truly interchangeable.
The FHFA has promised to keep an eye on the concern and potentially explore alternatives to the fee. It will likely have some time to do it, critics have generally acknowledged. Since the Federal Reserve is still holding a lot of the market’s mortgage-backed securities, shifts in investor sentiment may not immediately materialize. If they do, things will likely tilt to the disadvantage of Freddie, the smaller of the two agencies, researchers at the institute have said.
The deemed issuance ratio for 2023, in which the FHFA sets a percentage mix between Fannie and Freddie securities for tax purposes, will strike a little more of a balance between the two enterprises in 2023 than it did this year. The ratio for next year will be 53% Fannie/47% Freddie. This compares to a 56% Fannie/44% Freddie split for 2022.