Welcome to The S-Curve
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The name of the blog, the S-Curve, is a reflection of our logo and the central feature of our prepayment model. S-curves are seen in nature in many phenomenon, from population growth to prepayment and default models. Our first S-curve, in the early 1990s, used the arctangent function, then piece-wise linear functions, and evolved over time to be more complex and vary by FICO, loan size and LTV. This evolution encapsulates both the timeless nature of fundamental relationships and constant innovation to describe them better over time.
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Drivers of Discount PrepaymentsThoughts
As interest rates rise and fewer loans with refinancing incentive remain, other factors are primed to play a larger role in determining prepayment speeds in the coming months (and perhaps years). Turnover, the rate at which people move, is the most cited of these factors. In this blog post, we’ll consider two other potential drivers: curtailments, or partial prepayments, and mortgage payoffs that don’t involve taking out a new loan.
The charts below the rates of curtailment and payoffs in a sample of Fannie Mae loan level data[1].
Curtailments involve borrowers making additional payments beyond their amortization schedule yet short of paying off the full amount, i.e., people making an extra payment each month. In the charts we can see the rate rising slightly over time (which is mainly attributed to age; this data only has loans originated after Jan 1999, so the earlier months are limited to younger loans) and settling into a rate around 1.5-2.5 CPR. However, there was also a bit of a jump during the pandemic, which can perhaps be attributed to borrowers having extra cash from stimulus payments.
Full payoffs involve paying off a mortgage completely without moving or taking out a new mortgage, which tend to occur if borrowers find themselves with enough cash to cover the outstanding balance. While this can’t be known with 100% certainty, we’ve estimated the rate by looking at payoffs with a remaining term of 36 months of less. These are unlikely to be refinances and while we can’t rule out the possibility of the borrowers moving, we observe payoff rates loans with short remaining terms to be dramatically above the baseline turnover level. In essence, this chart shows the percentage of loans with short remaining terms (low) multiplied by their payoff rate (high) to get the overall contribution to CPR. Like curtailment, the data takes a while to ramp up, but then settles into 1-3 CPR range.
Both series represent a small percentage of prepayments in normal environments, but a greater percentage of the overall level in a world without refinancing. While it’s not a given that these numbers will remain constant in the face of rising rates, it is likely that these factors won’t have quite the same sensitivity to rates as refinancing (this study found payoffs to be relatively flat at negative incentive[1]). If rates stay high, it may be useful to keep these factors in mind moving forward.
[1] https://www.philadelphiafed.org/-/media/frbp/assets/working-papers/2019/wp19-39.pdf
[1] https://capitalmarkets.fanniemae.com/credit-risk-transfer/single-family-credit-risk-transfer/fannie-mae-single-family-loan-performance-data
The S-Curve Archives
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Thoughts
Summary
In 2021, Andrew Davidson & Co. Inc. (AD&Co) proposed a benchmark cohort approach to setting Ability-to-Repay (ATR) Qualified Mortgages (QM) standards. Successful benchmarks based on data are model-free and transparent, and the cohorts must perform consistently in comparison to one another and across time. Our original work used data through the early stages of the pandemic when non-performing loan percentages skyrocketed.
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ThoughtsHow Lowering Capital Costs Affects Higher-Risk Loans
Government-sponsored enterprises (or GSEs) are companies that provide guarantees and financing to originators through the mortgage secondary market. The size and resilience of the GSE secondary market maximizes diversification and liquidity which reduces financial risk and cost of capital. This benefit accrues to conforming borrowers through lower mortgage rates and resiliently available financing.
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ProductsThe release of Andrew Davidson & Co., Inc.’s (AD&Co) new generation of financial engineering tools marks a shift to a new reality; when the traditional benchmark for MBS valuation, the LIBOR/ Swap yield curve, becomes unavailable. Our recent Product Release email informed our readers about the change. In short, our users can:
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ThoughtsFHFA held a listening session for interested parties on its proposed rule on the GSE process for credit scores. The objective is making mortgage underwriting and pricing more accurate and more fair while balancing practical implementation by firms in the mortgage ecosystem. Along with many others, I had the opportunity to provide insights on this proposed rulemaking.
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ThoughtsIn our January 19th blog entitled, A More Equitable Lending System Will Not Be Created by Accident, we described the efforts it will take to overcome not just bias in lending today, but the systemic factors that have limited access to credit in the past and have created an unjust system.
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ThoughtsIn this short blog post I discuss some developments taking place in the flood insurance landscape in the US and look ahead at a few potential directions things could go. I suggest that universal catastrophic flood insurance coverage with a continuation of the introduction of risk-based pricing would be a significant improvement.
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ThoughtsIntroduction
The Government-Sponsored Enterprises (GSEs) entered conservatorship in September 2008. One could view the succeeding thirteen years as a journey back to financial stability with a refined operating model that looks more like a financial utility than a hedge fund. This business model is more compatible with a fair lending mission for a standard-setter that maintains secondary markets under an effective regulator. The GSEs remain the largest part of the housing finance backbone and a resilient funding source during economic stress.
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Thoughts
Around 75% of white American families were homeowners in the first quarter of 2020, according to data from the United States Census Bureau. However, only 44% of Black American families owned their homes at the same time.
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Thoughts
According to a report by the Research Institute for Housing America, climate change risk is rapidly increasing in the housing industry and will continue to demand more attention and regulation in the near future.
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Thoughts
Mortgage market participants are keenly aware that the Federal Reserve has been scaling back its UST and MBS purchases and factoring the outcomes of its actions on stakeholders across markets.