The Federal Housing Administration (FHA) on Wednesday announced policy changes it said were designed to strengthen the FHA's capital reserves. The FHA changes are expected to have little impact on housing, or Ginnie Mae supply and prepayments.

The agency said it would increase the up-front insurance premium that borrowers pay at closing to 2.25% from 1.75% beginning this spring. 

For borrowers with a FICO score below 580, the FHA is increasing the down payment to at least 10% from 3.5%. Also, it said it would propose limits that sellers can contribute on closing costs or free upgrades to 3% of the home's value from 6%.

The last two changes will be posted in the Federal Register for comment and would go into effect in the early summer.

Credit Suisse analysts donot expect that the higher mortgage insurance costs and reduction in seller concessions will hamper housing activity as a good portion of these costs can be rolled into the loan amount, and so they will not require borrowers to put down more cash.

Analysts added that the FHA allows borrowers to roll the upfront premium into the loan without it counting toward LTV. 

As far as the increased down payment for FICOs below 580, "this change appears to be nearly inconsequential, in our view," said Barclays Capital. New FHA purchase originations with FICOs under 580 have been less than 0.5% of loans.       

At most, the impact to Ginnie Mae issuance when these changes are all in place, said Credit Suisse, should be around 5%. Not all the impact will be felt in 2010 as some of the changes do not go into effect until the second half of this year.

Furthermore, Barclays Capital analysts said that the tightening in credit standards should not have much of an effect as many FHA lenders have already tightened standards. This is based on the FICO characteristics from late 2007 to present. 

As far as prepayments go, Barclays analysts expect only a marginal impact. The changes have lead to a slight decrease in the refinancing incentive for both existing and new GNMA loans, they noted. 

Additionally, previous changes already initiated by the FHA such as tighter lending standards for streamlined refinancing and new rules that limit servicer buyouts related to loan modifications reduces involuntary buyout risks. 

"All in all, we expect new origination GNMA pools to have faster voluntary prepayments, less buyouts, and worse convexity than earlier vintages," they concluded. 

BNP Paribas analysts agreed and said that there shouldn"t be an "outsized impact" on 6s and 6.5s, while speeds on 5s and 5.5s could see some slowing. 

While little change is expected near term in GNMA MBS valuations as a result of high involuntary prepays, Credit Suisse analysts believe that longer term, valuations should benefit from the higher upfront MIP, with cuspy GNMA coupons benefiting the most.

As a result, they suggested for investors to "fade any excessive enthusiasm for GNMA/FNMA swaps on this announcement given the pace of delinquency buildup in recent vintages (including 2009)."

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