- Fannie Mae and Freddie Mac started disclosing social data for U.S-agency mortgage-backed securities (MBS) at the end of 2022.
- Updating MSCI’s mortgage-prepayment model with this data, we found that MBS pools backed by more socially disadvantaged borrowers displayed notably different prepayment characteristics from those of other pools.
- Specifically, prepayment in these pools tended to be lower, reflecting both a lower propensity to refinance and lower housing turnover.
Last November, Fannie Mae and Freddie Mac posted a one-time historical file providing the so-called social-criteria share (SCS) and social-density score (SDS) for all active and inactive pools of U.S.-agency mortgage-backed securities (MBS) issued since January 2010. Beginning in December, the agencies also started to publish these metrics for newly issued MBS pools.1 This new framework could help investors gain new insights into the individual pools — and design new investment strategies accordingly — and potentially provide the foundation for socially conscious MBS investment. In this blog post, we illustrate the social dimension of MBS investment through the lens of a new MSCI prepayment model enhanced with social data.
How social data and prepayment risk have correlated
Some MBS investors may be willing to pay more for certain pool attributes due to their favorable prepayment profile. For example, they can look for pools with low loan balances, as they tend to be less reactive to interest-rate movements, because the fixed refinance costs are more prohibitive compared to loans with large loan balances. But what might investors glean from these pools’ social attributes? During the period of our analysis, pools with higher social scores tended to be less responsive to rate changes, as indicated by the prepayment s-curve in the exhibit below.2 For instance, when the loans were 200 basis points (bps) in the money, pools with above-70 SCS prepaid at an average conditional prepayment rate (CPR) of less than 40, while pools with less-than-70 SCS prepaid at a CPR of about 55. Therefore, high-SCS pools tended to offer investors significant call protection against prepayment risk.
Mortgages with higher social scores were less responsive to rate changes
Data from January 2018 to April 2023. Loan age between seven and 36 years. Loan balance above USD 200,000. Source: Fannie Mae, Freddie Mac, Recursion, MSCI
Mortgages with higher social scores faced more turnover hurdles under current economic conditions
Data from July 2022 to May 2023, where the listed coupons are all deeply out of the money to eliminate rate refinance. Source: Fannie Mae, Freddie Mac, Recursion, MSCI
When interest rates are high, slower base prepayment — e.g., from housing turnover — will delay the expected repayment to investors, which is a negative for discount bonds. The exhibit above shows loans with higher social scores exhibited lower prepayment propensity under a discount environment in the past one-year period across various coupons. When interest rates were high and housing prices elevated, borrowers with more adverse economic conditions appear to have been less likely to sell their existing homes, which would probably mean having to make more payments. Meanwhile, borrowers with lower social scores tended to be less sensitive to macroeconomic conditions.
New social-index data may enhance prepayment modeling
The MSCI Agency MBS Prepayment Model (Version MSCI2.1) has been parameterized to incorporate the new social-index data.3 Using the updated model, we looked at the option-adjusted spread (OAS) as of April 28 across the uniform-MBS 30-year coupon and social-score buckets. When the coupon was not deeply out of the money, bonds with higher social scores offered higher OAS. For deeply out-of-the money coupons, such as 2.0%, the shape was reversed. Bonds with a lower social score tended to have moderately wider OAS, due to their faster prepayment in the current macroeconomic environment to pull the discount forward to par faster than others, dominating the adverse refinance aspect of the prepayment risk.
OAS differentiation across uniform-MBS 30-year coupon stack and SCS buckets
Source: MSCI Agency MBS Prepayment Model, MSCI Two-Factor Interest Rate Model
In summary, the new social-index framework released by the agencies has expanded options for investors focused on socially conscious investment. We explored the relative values across MBS pools with different social index scores, revealing different investment characteristics of MBS pools backed by more socially disadvantaged borrowers.
1“Fannie Mae Launches New Single-Family Social Disclosures.” Fannie Mae, Nov. 16, 2022
2Refinance risk is due to the early repayment of the mortgage, as prevailing interest rates drop, eroding the premium that investors pay upon the purchase of the pool.
3To avoid multicollinearity issues — e.g. lower loan balance pools tended to have higher social scores — we applied a stepwise regression principle for model fitting, basically minimizing the residual model errors based on the new pool-level social-index data.
Further Reading
MSCI Agency MBS Prepayment Model Version MSCI2.1
MSCI Agency MBS Model Performance Review 2022