MBS prepayment numbers for August are expected to jump, in part because of an increased number of days on which mortgage holders can finalize a refinancing. The market is projected to see the opposite effect in September, which will have fewer such days.

The number of "collection days" increased to 23 in August, from 21 in July, while September will see only 19. Meanwhile, historically low mortgage rates set in July continued in August, with the 30-year, fixed rate averaging 3.55%, down from 3.68% in June, and the Refinance Index rose an average of 1.8% in July after a nearly 19% surge in June, all of which contributes to an expected uptick in August MBS prepayments.

Thirty-year Fannie Mae prepayments are projected to increase by nearly 10% on average in August, with 2011 and 2010 vintage 3.5s through 4.5s recording the largest percentage gains at roughly 15%. The August agency MBS prepayment reports will be released late afternoon on Friday, Sept. 7.

For September's report, which will be released in early October, speeds are expected to decline close to 10% on average as a result of the lower day count, while October will record modest gains on three additional collection days, or 21 total days.

The 3.5s, which generally have higher balances than higher coupon mortgages, have been particularly responsive to historically low interest rates, and refinancings should start to roll up into 4s, 4.5s and even higher coupons, JPMorgan Securities analysts said in recent research.

The Mortgage Bankers Association (MBA) indicated that the size of the average loan being refinanced dropped from close to $240,000 when the Refinance Index hit its recent peak in late July to closer to $200,000 currently. Generally borrowers with larger loan balances tend to be more responsive to rate levels and lenders pay greater attention to refinancings of larger mortgages. As such, JPMorgan analysts expect "the prepay curve to disinvert and steepen over the next several months." The analysts added that the increase in refinance rates since the beginning of August is likely to hasten this process.

 HARP Speeds Near Peaks?

Meanwhile, the August prepayments for loans that qualify for the Home Affordable Refinance Program (HARP) are expected to rise 8%, which looks to be the peak in constant prepayment rates on the HARP coupons. However, there are some upcoming tweaks to the program, which should keep speeds firm into 2013.

In early August, Federal Housing Finance Agency Acting Director Edward DeMarco said that, based on feedback from lenders regarding the HARP 2.0 changes, "a few operational adjustments to further simplify this process and increase the number of loans approved for refinancing" had been identified and updated guidance was forthcoming.

JPMorgan analysts cautioned that "continued retooling, such as cross-servicer HARP, could keep super-premium speeds elevated for a longer period of time than our base case assumptions."

While the changes made last November to HARP have increased participation, the latest quarterly Senior Loan Officer Opinion Survey indicated that 52% of the responding banks had "very little participation in HARP 2.0." It appears many lenders are still reluctant to do cross-over refinancings and capacity constraints are a strong factor.

For example, Bank of America Merrill Lynch analysts said in their prepayment outlook that as long as rates remain at or near record lows, they expect servicer capacity to focus on the easier-to-refinance borrowers, which temporarily shifts capacity from HARP. As that activity winds down, however, capacity will return to HARP loans, which should contribute to increased speeds. Meanwhile, JPMorgan analysts suggested that the more efficient HARP lenders, such as Chase, whose pool of eligible borrowers is decreasing, redeploy this freed-up HARP capacity to cross-servicer refinancings.

BofA Buyout Risk in GNMAs

Ginnie Mae I speeds are projected to show similar increases in aggregate to conventional loans. However, August speeds on 3.5s are expected to surge by roughly 30%, from July, on 2011 and 2010 vintages, and 20% on 4.0s in response to the attractive mortgage rate levels. The 4.5s and 5.0s should also still show some influence from the Federal Housing Administration mortgage insurance premium reduction for pre-June 2009 borrowers that became effective on June 11.

Meanwhile, 6.5s, 6.0s and 2010 5.0s are expected to be 10%-15% higher as a result of Bank of America delinquency buyouts. BNP Paribas analysts have noted that the 5% delinquency threshold, which requires a servicer to buyout delinquent loans, might not exceed the cap in September. This portends that October could see a large scale buyout.

Buying out the delinquent loans on 5.5% and higher pools will have a minimal impact on the 5% delinquency target, Deutsche Bank Securities analysts pointed out in recent reports. However, the 5.0% cohort is where a significant improvement would be made.

"Buying out every loan would reduce the 90+ DPD rate by more than 1.5% to about 3.0%," they said, versus 0.85% for 5.5s and higher.

Exactly when, where and how much remains uncertain in regards to BofA's buyout activity, and Deutsche analysts warned that, "for holders of high coupon Ginnie Mae, caution is the watch word" for now.

Low Fed Fund Rates

As of ASR's deadline, the odds of quantitative easing happening in September were at about 70% and thus not totally priced in. Back in July, when the markets anticipated the Federal Open Market Committee (FOMC) would extend its low rates outlook in its August meeting with asset purchases starting in September, the quantitative easing implied probability had been at 80%.

Currently, many participants expect the FOMC to extend this rate outlook from late 2014 to late 2015 during its Sept. 12-13 meeting. The board's minutes said an extension might be particularly effective if done along with a statement indicating that a highly accommodative monetary policy stance might have been maintained as the recovery progressed.

As for MBS asset purchases, it is not a matter of "if" but "when" as "many participants expected that such a program could provide additional support for the economic recovery, both by putting downward pressure on longer-term interest rates and by contributing to easier financial conditions more broadly," the minutes said. Though thoughts now are that they will wait until after the presidential election in November.

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