Recently, the Federal Housing Authority (FHA) announced the elimination of upfront refunds of mortgage insurance premiums for borrowers refinancing out of FHA loans. This is expected to lower Ginnie Mae MBS volumes and noticeably affect the prepayment behavior of its securities.
Noting that FHA loans make up 69.1% of Ginnie Mae outstandings, UBS said that these modifications on FHA refinancing incentives and flexibility "directly impact the prepayment and issuance behavior of GNMAs."
In a recent letter, the FHA announced the removal of the refund - excluding borrowers refinancing into another FHA-insured loan - effective for mortgages endorsed for insurance on or after Dec. 8, 2004. It also shortened the refund schedule for borrowers who refinance into another FHA-insured mortgage to three from five years.
Prior to the change, all FHA borrowers were required to pay a 50 basis point annual mortgage insurance premium aside from shelling out a one-time, upfront 1.5% insurance premium. Borrowers were also given a pro-rated refund of the upfront premium should they refinance within five years.
UBS analysts noted that by applying both the aforementioned changes to loans insured beginning Dec 8, 2004, this effectively includes almost all FHA loans backing 2005 GNMA pools.
"New FHA borrowers have significantly less incentive to refinance conventionally and slightly less incentive to refinance into another FHA," analysts wrote. "More broadly - new FHA loans are less attractive financing vehicles, and FHA market share is likely to suffer."
UBS said that the new FHA refund rules are definitely unfavorable to current FHA borrowers, although they noted that FHA caters to low-income, first-time borrowers who are usually less sophisticated than their conventional counterparts, making it unclear just how much these borrowers understand about what the new rule entails. Analysts said that while they had no way of really quantifying the precise impact of the changes, they estimate that it would cause a 10% to 15% dip in FHA originations, hampering Ginnie Mae's recent attempts at reestablishing market share (see ASR 1/10/06). This might reduce GNMA supply by roughly 10%, bringing down monthly issuance to 9% of total Agency supply, instead of 10%.
UBS analysts added that the more important effect of the modifications is on prepayments. The removal of insurance refunds for FHA-to-conventional refis, along with smaller refunds on FHA-to-FHA refis would probably slow 2005 GNMAs versus more seasoned vintages, analysts said, by an estimated 1 to 3 CPR slower for long-term 2005 GNMA speeds throughout the coupon spectrum.
Aside from this, analysts also expect slower seasoning curves for new GNMA pools. In a less robust housing sector, 2005 GNMA speeds would probably slow 1 to 2 CPR for at-the-money pools, but remain comparable for deep discounts and super premiums. Overall, UBS said that the changes would probably result in 2005 GNMAs having somewhat greater extension risk, but marginally slower speeds when modestly in-or-at-the-money.
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