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JPMorgan analysts: Steepening of GSE prepayment curve now complete

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Prepayment speeds on mortgages sold to or insured by government-sponsored enterprises are down 40% from their peak in December, according to JPMorgan Chase (JPM) analysts. Fannie Mae said its aggregate 30-year prepayments fell 21% in February from the prior month led by declines in lower coupons. Analysts in the banking giant's mortgage-backed securities strategy team said the aggregate prepayments for Fannie Mae 4.5s and 5s are down 70% and 45% since their high watermark at the end of 2010. "The steepening of the prepayment curve is now complete," the analysts said. JPMorgan said near-term prepays will be dictated by variations in turnover speeds and collection days because the refinancing index is "stuck" in the low 2000s and mortgage interest rates are settling around 5%. The analysts also expect prepayment speeds to rise slightly from the traditional 50% increase in housing turnover between February and June. "The weak state of the housing market, however, suggests that the upcoming seasonal increase should be more muted," according to the JPMorgan analysts. With distressed sales accounting for roughly one-third of all existing home sales, the seasonal increase in activity will be 30% to 40% "lower, translating to a more modest" increase in prepays over the coming months, the analysts said. They also expect the purchase share of mortgage applications to rise to nearly 50% from the roughly 35% currently and 20% in the third quarter of 2010. JPMorgan analysts expect organic net issuance of $100 billion to $150 billion this year with roughly $900 billion of gross agency fixed-rate issuance. Analysts at Barclays Capital said some market participants were concerned higher mortgage interest rates and a lack of volume prompted originators to aggressively refinance higher coupons in February, especially HARP-eligible pools. "We never bought into this theory, and instead have argued that the smaller decline reflected a longer lag in these cohorts owing to a smaller loan size and worse credit," the BarCap analysts said, citing the latest Fannie Mae report to support their view, as "the 2008 5.5-6s have posted a bigger (monthly) drop than last month relative to lower coupons." The analysts believe uncertainties surrounding prepayment speeds have come down dramatically as most of the slowdown caused by the sell off over the past few months "should have materialized." Write to Jason Philyaw.

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