There has been discussion that since many of the credit-eligible borrowers are out of the refinancing window, mortgage bankers will use the freed-up capacity to concentrate on the harder-to-refinance, credit-impaired borrowers.

Mortgage bankers will focus on this sector especially with delivery fees set to increase in a couple of months, while the Home Affordable Refinance Program is scheduled to end on June 30, UBS analyst Jeffrey Ho said in an earlier report.

Amherst Securities Group (ASG) analysts also suggested that unused capacity at mortgage bankers - now that rates have moved high enough to remove many of the easier-to-refinance borrowers from the window - could be diverted to the more credit-impaired borrowers.

Taking 2008 Gold 6s to illustrate, they think Wells Fargo has fewer "easy-to-refi," credit-impaired borrowers - or those without mortgage insurance. The firm seems to have been more active for some time in refinancing these borrowers as the underlying speeds on its loans have been faster than other servicers.

However, ASG analysts noted recently that Wells Fargo has ramped up speeds on loans with mortgage insurance, which indicates increased focus on the more difficult-to-refinance borrowers.

Meanwhile, Chase will likely have more loans available for refinancing, "which could curb their speed decline in this cohort." The other major servicers like CitiMortgage and Bank of America, however, have persistently been slower than Wells and Chase. ASG analysts warned that "there is a risk that they begin to refinance these borrowers more aggressively, which would push speeds higher."

However, they said that "this could provide a lift of a few CPR to premium speeds; we don't expect the impact to be too large because many borrowers face insurmountable obstacles to refinancing."

Still, based on ASG's analysis of buyouts and available banker capacity, they predicted that most premium cohorts will show only a small drop over the next few reports and will have a much smaller pickup in this rally. The lower coupons that reacted more strongly will decrease at a more precipitous pace, analysts said.

 

Prepayment Speeds to Plunge

Prepayments over the next two months are projected to decline sharply. This is in response to higher rates, lower refinancing activity and a reduced number of collection days.

After declining to a record low of 4.17% in mid-November, 30-year fixed mortgage rates steadily backed up to 4.86% by the end of December, according to Freddie Mac's weekly survey, with the no-point rate hovering above 5%.

Over the same time, the Mortgage Bankers Association's Refinance Index plummeted more than 50% to the 2100 area.

At an effective mortgage rate less than 5%, FTN Financial analysts estimated that less than 18% of the 30-year conventional market was 50 basis points in the money after taking into account loan balance, LTV and FICO.

Meanwhile, Scott Buchta, head of investment strategy at Braver Stern Securities, calculated that nearly half of the 30-year conforming universe was out of the 40-basis-point refinancing window, and factoring in increased closing costs, "it can be argued that well over half of the 30-year universe is now out of the money."

The current outlook has conventional speeds declining 20% on average in January with 5.5s and lower showing the largest percentage declines at 20% to 30%, respectively. In addition to the decline in refinancing, the day count falls to 20 from 21 in December. However, the higher premium coupons are expected to show a smaller drop in part due to delinquency buyouts.

In February, speeds are projected to decline an additional 20%. While mortgage rates have eased back to the mid/low 4.70s area by the later part of January, refinancing response has remained muted while day count will decline to 19.

It is notable that by the February report - which will be released in March - FNMA 2009 and 2008 vintage 4.5s are expected to prepay at 11 and 21 CPR from 24 and 41 reported in December. Meanwhile, similar vintage 5s are estimated to prepay at 16 and 24 CPR compared with 27 and 42 in the last report, while more seasoned vintages are expected at around 20 CPR from 30+ CPR.

GNMAs are also projected to decline ~20% in January, but February is looking more modest with around a 10% slowing.

 

Higher Total Agency MBS Net Issuance

Overall, paydowns on FNMAs, FHLMC Golds and GNMAs are projected to total $102 billion in January.

Month-to-date through Jan. 26, gross issuance totals $121 billion, placing net issuance at more than $20 billion. This is potentially its highest level since fall 2009.

Heading into 2011, various MBS analysts warned that the sector faced increased "headwinds" from the supply end as private investors will have to pick up the slack - including the Federal Reserve's MBS paydowns - as the government is no longer the marginal buyer.

While banks are expected to do their share, money managers are more responsive to relative value and overseas investor support remains tepid.

"Net new issuance and secondary supply could outstrip demand by more than $200 billion this year - even with steady bank demand," warned Steven Abrahams, head of securitization and MBS research at Deutsche Bank Securities, in a recent report.

He added that crossover relative-value investors will be needed to be a backstop to spreads.

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