We continue to field questions on speeds within higher coupons. Base case, we think the model is likely to slow on these higher coupons and likely undershoots historicals, especially considering the changes to the conforming loan limits in pools.
General Thesis:
- Speeds into -50 to -125bps scenarios are likely too slow on models.
- The negative convexity of current coupon Cheapest to Deliver (CTD) is likely worse than most think.
- TBAs should lose duration into a rally faster then they have in the past.
- Carve outs of ANY call protected story should shift up from a pay-up perspective for this foreseeable future... Bullish for quality Specs
We did this fast and this requires far more analysis but the quick thought is:
Start by taking the S-curves on the majors (shown below from RiskSpan)
Run YB Scenario Analysis for Current coupons:
** -50 to -125bps parallel shift scenarios
** Running a 6 month gradual shift and a 12 month gradual shift
Examine the projected speeds at the horizon
Take current mortgage Rate 6.63% (YB mtge rate), Subtract 50, 75, 100, 125 bps to find new mortgage rate
** this is assuming primary secondary spreads stay the same, can be noise here given rates may not move 1:1 with the curve
Compare the Historical Major S-curves to what YB projects in these scenarios
Example: 30yr 6s with the WAC at 6.916 on the cohort, a -75bp parallel shift means these bonds should be 103bps in the money.... (6.916 WAC vs 5.88 Assumed NEW CC Rate)
At the 6 month horizon speeds are projected to be 34.023 CPR. S-curves says speeds will be 51.83cpr, meaning large difference between YB projected speeds and historicals.
Conclusion:
The difference between historicals and YB projected speeds is large. YB may be too slow, or historicals may be too fast.
Historicals were from an environment where:
- Housing prices were moving up 20% per year
- We had a Bull market in risk assets the economy was flying
- Housing affordability was near the highs
- Inflation was high
Current environment we have:
- less housing supply
- slowing inflation
- tightest affordability market in history (upgrade housing trade may be harder)
This means speeds likely fall somewhere in between. There is a dynamic now with the float having a ton more negative convexity in it which would support speeds to be on the higher end of the range given the Refi incentive is likely a TON higher now on these current coupon cohorts.
We think this is positive for specs in a big way, The OAS between the TBA and spec pools is likely to tight... the TBA needs to have a higher option cost applied to it vs what is being applied to call protected spec pools.
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