Mortgage prepayments slow to a crawl; steadily declining prepayments are likely to continue at a snail's pace as a fall off in first-time homebuyers begins to take hold.
Steadily declining prepayments are likely to continue at a snail's pace as a fall off in first-time homebuyers begins to take hold.
Prepayment rates of Freddie Mac and Fannie Mae pass-throughs have declined steadily since 1986, because of diminished housing demand, reduced home price inflation and weakening demographics. Pools backed by conventional mortgages originated since 1985 are paying down even more slowly than those made up of older loans written in the 1970s. We expect that a falloff in the number of first-time homebuyers will accentuate the slowing prepayment trend in the 1990s.
The mortgage securities market, however, has not fully adjusted to this prepayment shift--the prices of many sectors still reflect the faster prepayments seen a few years ago.
Prepayment rates since 1986 are summarized in Figure 1. They are expressed as percentages of the Public Securities Association standard prepayment model (PSA), for "old" Freddie Mac and Fannie Mae 8s, 9s and 10s. These pools have remaining weighted-average maturities (WAMs) of 22 years or less and are made up of conventional mortgages originated in the 1970s. The prepayment rates of these older pass-throughs have fallen steadily during the 1986-89 period. Prepayment rates of the other coupons have declined comparably.
Rising interest rates since 1987 account for some of the slowdown in these prepayment rates. However, the magnitude of the fall off cannot be explained by interest rate movements alone. Even adjusting for interest rate levels, prepayment rates of these securities have slowed steadily since 1986. (We focus in this report on the decline of Freedie Mac/Fannie Mae prepayment rates. GNMA prepayments also have slowed during the past few years, but to a much smaller degree. We can speculate that shifts in the economic forces fueling housing activity, such as reduced home price inflation, have less impact on moderate income FHA/VA borrowers than they do on conventional mortgage borrowers.)
Moderately seasoned securities
The interest rate path of the past decade created two distinct segments of 8 percent to 10 percent mortgage pass-through securities: those backed by loans originated in the 1970s, and those made up of loans written since 1985.
As illustrated in Figure 2, the amount outstanding of the newer issues has grown rapidly and now exceeds that of older pass-throughs. "Moderately seasoned pass-throughs"--those issued since 1985 that are now at least two years-old--also now surpass in volume the amount of older pools.
As shown in Figure 3, the moderately seasoned pass-throughs are paying off even more slowly than the older securities. During the past two years, the prepayment rates of moderately seasoned Freddie Mac/Fannie Mae 8s, 9s and 10s have been 9 percent to 37 percent PSA slower than those of their older counterparts. Moderately seasoned 9s, for instance, prepaid at only 126 percent PSA during 1988 and 1989, compared with 163 percent PSA and 145 percent PSA for old 9s. These differences, however, appear to be narrowing with time. Based on recent prepayment experience, our projections for the moderately seasoned securities are about 20 percent PSA slower than for the old pass-throughs.
The slower prepayments of the moderately seasoned issues are of special significance because these securities represent the majority of the seasoned pass-throughs that are traded. Furthermore, moderately seasoned pass-throughs back essentially all interest-only and principal-only STRIPs collateralized by conventional mortgages.
Several factors have led to the slowdown in prepayments since 1986. The pent-up demand for housing caused by the high interest rate environment of the early 1980s was substantially satisfied during the 1984-1987 period. Because of high mortgage rates, housing starts plunged from an annual rate of 2 million units in 1978 to 1.1 million units in 1982. As mortgage rates subsequently declined, housing starts recovered and averaged 1.7 million units during the 1984-1987 period, before gradually falling to an estimated level of 1.4 million units in 1989.
Slower home price appreciation has reduced housing market activity--homeowners are less eager to trade up to larger homes if they do not expect to realize profits on their housing investments. The average price of existing homes sold increased by only 4.3 percent in 1989, after rising at annual rates of 6.3 percent in 1986-87 and 9.9 percent during the 1970s, according to the National Association of Realtors. Soft housing prices in many markets nationwide at present will further deter activity.
The prepayment difference between old and moderately seasoned pass-throughs is partly explained by the impact of ARM financing. Homeowners who are relatively mobile were attracted to ARMs in large numbers beginning in 1982. The corresponding population of fixed-rate mortgage borrowers has been less likely to move, and mortgages of these homeowners have exhibited slower prepayments. This phenomenon should not affect the prepayments of the older mortgages, which were originated before the advent of the ARMs market.
Another reason for the difference is the greater accumulated equity in the homes that were purchased in the 1970s, compared with those bought since 1985. Equity buildup promotes mortgage turnover by providing down payments for new home purchases and by enabling prepayments for cash take out refinancings.
Declining housing turnover
Throughout the rest of this century, demographic forces should continue to moderate housing turnover. The number of first-time homebuyers is expected to fall during the 1990s as the number of households headed by 25 to 34 year-olds declines by more than four million. Figure 4 shows the annual increase in households since 1960, with Census Bureau projections through the year 2000. After factoring in immigration, total household growth is projected to slow from an annual rate of 1.6 million in 1988 to 1.2 million by the year 2000.
At the same time, the population will shift toward an older age group. The percentage of households headed by people under the age of 35 is expected to decline from 29 percent in 1985 to 20 percent in 1990, while households headed by the 35 to 54 year-olds will increase from 35 percent to 44 percent. Ordinarily, these older families bolster housing activity by trading up to larger, more expensive homes. This process, however, will be limited by the lack of entry-level home buyers.
Migration levels between states should moderate
The 1980s witnessed high levels of migration between states. In addition to the long-term trend of population movement from the Northeast and Midwest to the sun belt, economic disruptions increased the levels of migration. The energy boom in Texas coincided with the severe recession in the industrial Midwest and led to a doubling of migration into Texas during the early 1980s. The oil bust that followed in 1984 and the industrial recovery in the Midwest reversed this trend in the mid- and late 1980s.
The Census Bureau and The Joint Center for Housing Studies also provide longer-term projections for the rest of this century. These long-term projections, while tentative, point toward declining inter-migration between states. All of this data supports the conclusion that slower prepayment rates are likely to be a hallmark of the 1990s. [Figure 1 to 4 Omitted]
Michael Waldman is a managing director, and Ravi Mattu and Mark Gordon are directors in Salomon Brothers' BPA-mortgage department in New York.
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|Author:||Mattu, Ravi; Gordon, Mark; Waldman, Michael|
|Date:||May 1, 1990|
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