The prepayment story in conventionals has gotten more interesting — for the near term at least — following last week's announcement from both GSEs that they would buyout 120 day (or more) delinquent mortgage loans. 

Freddie Mac said it would essentially complete this operation in February and so this would be reflected in the factor report released in March, while Fannie Mae will begin in March (April factor report) and extend the purchases over "a few month period."

Increased buyouts had been expected with the GSEs' adoption of FAS 166. However, most analysts thought that a more orderly pace will be adapted to limit the disruption to the market the same time the Federal Reserve was winding down its MBS purchase program.

Even after the buyouts are completed, Barclays Capital analysts believe that speeds should be faster than where they have printed in recent months as a result of more active buyouts as loans become four-months delinquent as well as from increased refinancing activity that will be more pronounced as the pool will consist of cleaner collateral.

"Consequently, we expect faster prepayments, worse convexity, and a steeper S-curve," they said.

 February Outlook

Regarding Freddie Mac, speeds are expected to surge in February. On average, 5s and 5.5s are currently estimated jumping 130% to 140%, 6s 220%, 6.5s nearly 300% and 7s by 370%. 

Speeds on 2007 6.5s are predicted to hit 90 CPR, while 2008 and 2006 vintages are seen at the 80 CPR area.  The 2008-2006 7s are predicted to prepay at over 90 CPR and nearly 100 CPR for the 2007 vintage.   

FNMA and GNMA 30-year MBS speeds, meanwhile, are expected to be down 1% on average in February.

Factors influencing speeds include an unchanged number of collection days — 19, a 4% decline on average in refinancing activity in January as mortgage rates ticked higher, while buyouts will be relatively muted.

March Outlook

For March prepayments (which will be reported in April), FHLMC Gold speeds are anticipated to drop over 50% according to Barclays analysts. This will happen as delinquency buyouts are essentially completed. Speeds on 2008-2006 6.5s are seen in the high 20 to low 30 CPR area and in the low 40s CPR for 2008-2007 7s.     

There is less clarity on FNMAs and Barclays analysts warned buyouts could be unevenly distributed and lead to "lumpy" prepayments. 

JPMorgan Securities analysts also pointed out that Fannie Mae indicated in their press release that the pace of buyouts would also be influenced on servicer capacity. They found this interesting as it implies that Fannie buyouts might need operational assistance from the servicers. In this case, they warned that buyout speeds could be "lumpy and perhaps servicer specific."

JPMorgan analysts believe large servicers should be in a better place operationally to help than smaller servicers. The initial call is for Fannie speeds to surge close to 80% overall in March (reported in April). Speeds on 2008-2006 6.5s are projected to jump to the 50-60 CPR area from 25-30 estimated in February. Similar vintage 7s are seen at 70-80 CPR. Revisions are expected as more Wall Street firms update their short-term forecasts. 

While the timing of the buyouts has severely impacted investors, there is some positive news in terms of the amount of dollars that will be placed back into the MBS sector. JPMorgan analysts calculated $200 billion will be bought out with around $130 billion to $140billion potentially being put back. 

Analysts said that while not all the proceeds will go back, assuming that just half gets reinvested is a positive for the basis.  "

To put this in perspective," they said, "the Fed has been buying about $50 billion per month recently. If half the investors reinvest their paydowns (i.e. $60 to $70 billion) this would represent about one to two months of additional Fed buying."  

GNMA Outlook

Turning to GNMAs, Credit Suisse analysts warned that the slowdown in servicer buyout activity is only short-term as delinquencies continue to ramp up sharply. They said there is "a significant risk that [Federal Housing Administration] finances will be outrun by losses by year-end 2010 or 1H11 due to the continued sharp ramp-up in delinquencies."

Currently, analysts believe that GMAC is most at risk of delinquency buyouts among the large servicers as its serious delinquency level was close to 5% as of the January factor report.

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