With cash-out activity set to account for a larger share of the mortgage market, we thought it worthwhile to compare some recent cash-out activity trends. For this analysis, the graphs consist of truncated S-curves, showing only the left-hand (out-of-the-money) side of the curve to focus on discount mortgage behavior in a rising rate environment where activity is more likely to be influenced by serial cash-out activity. 

This first chart compares recent performance of out-of-the money mortgages by loan purpose, comparing speeds for purchase loans (black) with both cash-out refis (blue) and rate/term refis (green). Notably, cash-out refis offer 1-2 CPR upside over rate/term refis, only converging to no cash out refis when 100bp out of the money.[1] 

In early 2021, GNMA began issuing a new class of custom pools with prefix “RG.” These pools are re-securitizations of previously delinquent loans which were repurchased from pools during the pandemic.[1] Loans in these pools are unmodified, keeping the original rate and term of the mortgage note. In the analysis below, we review the recent performance of these pools at loan-level detail. The first RG pools were issued in February 2021, growing steadily to an average rate of $2B per month from Q2 onward, with a total outstanding of $21 billion. 

With the Fed starting their tightening cycle and reducing balance sheet, mortgage rates have begun rising. Since late summer, 30-year conforming rates have risen more than 100bp, with 75bp of that occurring since the end of December. The recent flight-to-quality rally has temporarily eased that, but the overall trend remains in place for higher mortgage rates.

With this pivot, mortgage investors have switched from focusing on prepayment protection to mitigating extension risk. In this post, we offer analysis on extension risk and turnover speeds for various out-of-the-money Fannie and Freddie cohorts.[1]

In the chart below, we first focus on out-of-the-money prepays on lower loan balance loans. For this analysis, we analyzed speeds on loans that were 24 to 48 months seasoned. We further grouped the loan balance stories into meta-groups, as the traditional groupings of “85k-Max”, etc, showed little difference in out-of-the-money speeds. When compared to loans with balances above 250k, speeds on lower loan balance loans were a scant 1-2 CPR faster than borrowers with larger loan balances, when prevailing rates were 25bp to 100bp higher than the borrower’s note rate.

We further categorize the Fed’s holdings by vintage and borrower note rate (gross WAC) at the loan level. Using loan-level data (rather than weighted-average statistics published on Fed-held Supers or their constituent pools [1]) provides a more accurate view of the Fed’s distribution of note rates and hence prepayment exposure.

With significant home price gains over the last two years, U.S. homeowners are sitting on vast, mostly untapped wealth. Nationally, home prices are up an aggregate of 28% over the last two years, with some regions performing even better. But unlike other periods of strong home price gains, cash-out refinancings lagged overall refinancings during the pandemic rate-rally. In this short article, we look at cash-out refinancings over time, and their potential impact on prepayments, especially on discount cohorts.

A historical perspective

In the early 2000s, mortgage rates fell nearly 200bp, triggering a massive refinancing wave as well as a rally in home prices that lasted well into 2005.

During this early millennium rally, the market saw significant cash-out refi activity with homeowners borrowing at then-historically low rates to free up cash. The market even saw refinancing activity in mortgages with note rates below the prevailing market rate. In 2002, CPRs on some discount cohorts hit the low to middle teens, which many participants attributed to cash-out refinancing. Resetting a mortgage 50 basis points higher can nevertheless often lead to overall lower debt servicing when borrowers use cash-out refis to consolidate auto loans, credit cards and other higher-rate unsecured borrowings.[1] In the early 2000s, this cash-out refinancing activity led to overall faster speeds and a higher S-curve for out-of-the-money cohorts. How does 2002-03 cash-out refi activity compare to today? In the early 2000s, issuance of cash-out mortgages, as a percentage of the total market, varied between 1% and 2.5% of the outstanding mortgage universe each month.