A new report from Fitch Ratings found that U.S. prime jumbo residential mortgage-backed securities (RMBS) issued since the start of 2010 are unlikely to see a "meaningful increase in prepayments, even if interest rates stay low." The company believes that the lack of prepayments will result in an increased average life of the mortgages in these trusts, further increasing the period of default risk.
Although mortgage rates have recently declined, the average annualized prepayment rates for recent RMBS remained around 5 percent in May—down from 25 percent a year ago. "We expect the 2013 vintage to be one of the slowest prepaying vintages on record in US RMBS as mortgage rates are unlikely to decline from the levels at which those mortgages were originated," Fitch said in a release.
The slow prepayment behavior exhibited could expose the trust to a longer period of default risk from increased credit risk. However, Fitch believes that the bonds in the recent vintage of RMBS are protected against default risk by the "unusually strong" initial credit profiles of the borrowers.
For example, borrowers in the 2013 vintage benefited from over 30 percent equity on average and are being helped by strong home price growth since the loan's origination. Fitch notes that if underwriting loosens in the near term, the protection against this term risk could decline.
"Global economic uncertainty has pushed mortgage rates down to the lowest level in 6 months for conforming loans and 12 months for jumbo loans. Rates overall have declined roughly 25 basis points in 2014, but remain almost a full point above their all-time lows from a year ago, providing limited refinance incentives for borrowers in recent RMBS," the company said.