On Oct. 24, the Federal Housing Finance Agency (FHFA), along with Fannie Mae and Freddie Mac, announced significant changes to the Home Affordable Refinance Program (HARP).

These modifications will make more homeowners eligible to refinance their mortgages and allow them to tap the current historically low interest rates.

HARP is the only active program that allows homeowners who are underwater to refinance.

Bank of America Merrill Lynch analysts said FHFA's HARP modifications have pushed the MBS universe back to the causes of the current crisis, namely low documentation requirements, less focus on the underlying loan value and more emphasis on faster mortgage processing.

However, recent experiences with rep and warranty violations have now forced originators to "view the world through a darkly tinted lens," analysts said. While the HARP updates will no doubt increase the program's output, it's too early to fully project how originator safeguards will limit the prepayments resulting from the policy shifts, they said.

The "upgrades" to the program include removing the 125% LTV cap; extending the HARP date to 12/31/2013 for loans originally sold to the GSEs on or before 5/31/2009; eliminating loan-level price adjustments (LLPAs) if borrowers refinance into a shorter mortgage, or lowering fees for other borrowers; waiving certain rep and warranty risks for borrowers who have been current on their mortgage payments for the past six months with no more than one late payment in the past 12 months; and eliminating new property appraisals if there is a reliable automated valuation model (AVM) estimate provided by the GSEs.

The GSEs have until Nov. 15 to release guidance with operational details to servicers and lenders about these changes. The FHFA press release said that some lenders may be able to accommodate mortgage applications by Dec. 1, while other changes, such as LTVs greater than 125%, should be operational by 1Q12.

Given this timeline, Amherst Securities Group (ASG) analysts estimated that if applications start getting filed in late December, these will close in February with prepayments starting to pick up in the March prepayment report.

Once the details become available, the Street's prepayment expectations can be fine-tuned to account for the changes.

Initial projections appear to be in two camps - some analysts think that speeds will experience around a 5- to 8-CPR increase while others believe there be an increase in the 10- to 15-CPR range for 2006-2008 vintage 5.5% through 6.5% coupons.

Most of the impact will be felt in the program's first year and less in 2013.

Influences on Prepay Speeds

The biggest influence on speeds is the waiving of reps and warranties. These were a very large bank-friendly set of changes that encourages the original servicer to refinance loans on which they have had put-back risk, but does little to encourage different servicer refis, ASG analysts noted.

AVMs, however, can serve as a limiting factor to increases that might result from the rep and warranty waiver. Two questions, for example, that Amherst analysts raised are what percent of loans will be deemed not to have a reliable AVM and will the automated appraisal be provided on different servicer refinances? On the first, they assume it could be 20% to 30% of the total, while they expect an answer to the latter question on Nov. 15 when the GSEs release their operational guidance.

In a conference call presentation, Barclays Capital analysts said that based on the information available, the HARP changes appear to be a harmonization between Fannie Mae and Freddie Mac implementations with the least restrictive guidelines adopted.

They added that since there is no significant difference between Fannie and Freddie speeds currently, they believe the rep and warranty change would probably have a minimal impact. They warned that changes announced on Nov. 15 can be more than what the current details would indicate.

The FHFA estimated that the HARP refinances "may roughly double or more from their current amount," which is 894,000 through Aug. 31. While questions apparently are starting to arise about whether that is doable, extending the end date of HARP to December 31, 2013, from June 12, 2012, increases the odds this goal can be accomplished. ASG analysts calculated that, based on data for the first eight months of 2011 of a run rate of 34,000 loans per month, 952,000 borrowers over 28 months can be refinanced.

In a conference call, Credit Suisse MBS analysts estimated that around 720,000 to possibly one million borrowers can be helped if there is a more successful implementation of the proposals.

Analysts added that the activity will likely be more front-loaded and subsequently trail off throughout 2013. Translated into dollars, they estimated that $125 billion in mortgages could be refinanced, resulting in $2 billion to $3 billion in annual interest savings. Analysts felt this was manageable for the mortgage market. However, in the grand scheme of helping the economy and housing, the impact will likely be minimal.

The other changes, including the 125 LTV cap removal and LLPA elimination, should cause only a very minor uptick on speeds. In terms of the cap removal, the universe of borrowers in this category is relatively small.

Regarding the latter, while the FHFA highlighted the savings and modest changes to monthly payments on shortening a mortgage term, Morgan Stanley's analysis suggested that a vast majority of borrowers will actually see a significant increase in their monthly payment by moving into a 15- and/or 20-year loan - even with the elimination of LLPAs. As a result, they expect the removal to have only a marginal effect on refinancing and therefore a minimal impact on 15- and 20-year issuance.

ASG analysts also said that they have trouble seeing many borrowers moving into a 15-year mortgage given the resulting sizeable increase in the monthly payments. They said that at the margin, the elimination of LLPAs can make a difference to 20-year loans, thereby increasing supply in that sector to some extent.

Near-Term Prepay Outlook

Prepayment speeds into January should be relatively uneventful, as refinancing activity has declined since hitting a year-to-date high in mid-August. For the week ending Oct. 21, the Mortgage Bankers Association's Refinance Index was at ~3545, a 27% decline from its peak of 4867. This is despite the additional declines in mortgage rates that have occurred into September and October. After 30-year fixed mortgage rates hit a record low of 3.94% in the week ending Oct. 6, according to Freddie Mac's weekly primary mortgage market survey, they have backed up to the 4.11% area. This retreat has reduced the refinancing incentive that borrowers underlying the 4% coupon have. In addition, the other factors limiting refinancing activity remain in place: tight underwriting standards, capacity constraints aimed at mortgage bankers, poor home values and a weak economy and jobs market.

The consensus outlook has speeds increasing less than 5% on average for conventionals for October, with the largest percentage gains in 4.0s through 5s at around 4% to 7%. November and December prepayment speeds are expected to increase less than 5%.

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