Freddie Mac's new, stricter guidelines for the delivery fee structure of 30-year mortgages might hinder refinancings.
The just-announced fee structure based on both FICO and LTV decreases the fee on low LTV/low FICO borrowers, while penalizing borrowers with high LTVs. These will become effective for settlements starting June 1. The updated guidelines came after both Freddie Mac and Fannie Mae increased delivery fees based mostly on FICO scores last November.
In this instance, Freddie Mac is ruling that for mortgages with an LTV greater than 80 and a FICO less than 740, the charge will be 9.5 ticks and increasing to 25 to 34 ticks for a FICO less than 720. Meanwhile, for a 60 to 80 LTV loan, an added charge of 16 to 24 ticks will be assessed if the borrower has FICO of less than 720.
Under the new guidelines, 15-year mortgages will not be impacted and neither will Freddie to Freddie refinancings. The maximum LTV allowed under these new rules is 97, with a 5% reduction for mortgages made under a declining housing environment.
RBS Greenwich Capital analysts believe that these changes are targeted toward the Alt-A borrower with FICOs between 680 and 720. These borrowers could easily see a 15 to 25 basis point rise in their mortgage rate, which further reduces the callability on high premium paper.
What analysts are really looking at is the effect on the number of refinancings. In the current housing environment, the new LTV-based fee structure is probably going to have a much larger impact on refinancing transaction costs compared with the original fee structure, analysts said.
"Clearly, some people who would have received a true' conforming rate will now get a somewhat higher rate to compensate for higher Freddie guarantee fees," said Art Frank, director and head of MBS research at Deutsche Bank Securities. "So these fees should modestly reduce refinancing."
Bear Stearns analysts said that in declining home price scenarios, the GSEs require a new appraisal when refinancing with the delivery fee based on an updated LTV. This is why this change is probably going to make the costs to refinance considerably higher in areas where home prices are dropping.
For instance, Bear analysts said that based on Freddie Mac's 2007 originations, the average delivery fee would increase to 0.76% under the new guidelines from 0.57% under the old fee structure, assuming that home prices remain unchanged. But, if home prices were to dip by 5%, the delivery fee increases even further to 0.97% under the new fee structure, analysts said.
According to Bear Stearns, the LTV-linked refinancing costs should make all agency MBS and IO cashflows appear much more attractive with today's dropping home prices. This is specifically true of premium coupons, analysts said.
For example, borrowers backing the 6.0% and 6.5% coupons usually have higher LTVs and lower FICO scores compared with borrowers backing their lower coupon counterparts. This is why analysts said that valuations of premium high LTV pools are probably going to benefit the most from these changes considering that the biggest increases in refinancing expenses are focused there.
It should be noted, Bear Stearns analysts said, that most originators are probably going to factor the delivery fee into their rate sheet and not in the closing costs.
As a result, a loan with a one point delivery fee is probably going to be delivered into a coupon that is trading at least a point above the par coupon. As an example, analysts said that a borrower with a 710 FICO and 82 LTV is probably going to pay a rate that is almost 27 basis points higher compared with the current prime conventional rate. In terms of prepayments, buysiders can look at this delivery fee as a shift in the refinancing elbow, analysts stated.
The valuation impact of the new fee structure is considerable for premium coupons, Bear analysts said, adding that in 6s, it can add as much as 10 basis points in OAS versus the old fee structure. Further, the combination of low FICO and high LTV would add 20 basis points to the base OAS of the 6.0 coupon, which reflects the much higher costs of refinancing as well as slower prepayments.
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