Could the lower rates accelerate pre‑payment risk in Freddie Mac’s existing loan portfolio?

Answer – Yes, lower rates can accelerate pre‑payment risk in Freddie Mac’s existing loan pool, and the market is already feeling the first‑order effects.

The PMMS now shows a 30‑year fixed‑rate mortgage averaging 6.58 %, down from the mid‑7 % range seen a few months earlier. A drop of even 0.5 %–1 % in the benchmark rate typically triggers a spike in refinance activity because borrowers chase the lower cost of borrowing. Freddie Mac’s portfolio, which is largely comprised of fixed‑rate loans originated at higher rates, therefore faces a higher pre‑payment speed (PSR). Faster pre‑payments shorten the expected life of the securities that back the agency’s mortgage‑backed‑securities (MBS) and reduce the net interest margin that Freddie Mac earns on its existing balance sheet. The net effect is a reduction in expected cash‑flow duration and an upward pressure on the agency’s weighted‑average coupon (WAC), which can compress the spread between Freddie‑Mac‑issued MBS and Treasuries. In a low‑rate environment, investors also demand a higher spread for the extra negative convexity, pressuring FMCC’s earnings outlook.

Trading implications:

* Equity side – FMCC’s share price may be pressured as analysts factor in higher pre‑payment risk and a potential dip in interest‑income earnings. A modest short‑to‑neutral position (e.g., 2‑3 % of the portfolio) could capture downside if pre‑payment‑driven earnings pressure materialises.

* MBS side – Expect a temporary rally in agency MBS prices as pre‑payments push yields lower, but the duration‑risk premium may rise once the pre‑payment wave is priced in. Investors can hedge by buying Treasury futures or by shorting agency MBS futures to capture a possible “rate‑flattening” rally.

* Spread‑play – The FM‑MBS spread (Freddie‑Mac MBS vs. Treasuries) is likely to tighten initially as demand for agency securities spikes, then widen as the market prices in higher pre‑payment volatility. Positioning in spread‑tightening trades (e.g., buying FM‑MBS and shorting Treasury futures) can capture the near‑term move, while a longer‑term spread‑widening hedge (e.g., FM‑MBS put options) protects against a sudden surge in pre‑payment volatility.

Overall, the decline in mortgage rates does increase pre‑payment risk for Freddie Mac’s loan portfolio, and the market will price this risk through lower equity expectations, adjusted MBS spreads, and shifted duration exposure. Traders should watch PSR metrics (e.g., Ginnie‑Fannie‑Freddie pre‑payment indices) and the 10‑year Treasury‑MBS spread for confirmation of the trade thesis.