MBS analysts have released their initial analysis on the impact of the changes to the Home Affordable Refinance Program (HARP) on MBS market.
This morning the Federal Housing Finance Agency (FHFA) has released details on changes to the HARP to increase the number of borrowers being refinanced through the program.
According to Bank of America Merrill Lynch analysts, FHFA's HARP modifications have pushed the MBS universe back to the roots of the current crisis with the low documentation requirements, less focus on underlying value, and more emphasis on faster processing.
However, this time around, the recent experiences with rep and warranty violations have forced originators to "view the world through a darkly-tinted lens," analysts said. While the HARP updates, they explained, will undoubtedly increase the program's flow, it is still too early to
fully project how originator safeguards will mitigate the prepayment torrent.
Meanwhile, days before the FHFA's announcement, even though MBS liquidity (specifically in mortgage derivatives) was less than ideal, Royal Bank of Scotland (RBS) analysts said market pricing seemed to show that any HARP impact would be modest.
But, after the announcement, the market saw higher coupons trade off significantly and experienced some weakening in the 15-year sector relative to 30-years, as a result of concerns around rising supply. Even though the changes were GSE supported, analysts do not expect that much 30- and 15-year refinancing since this will probably result in a higher monthly payment for the borrower.
The relaxation of certain reps and warrants, analysts said, was the most impactful change from today’s announcement. According to them, this should generate faster speeds in higher coupons (specifically in different-servicer refinancings). They said that even though the details were not really clear, RBS analysts think that the top of the coupon stack will be the most impacted. Rep and warrant risk is the no. 1 cause of slow prepayments to date, analysts said.
The use of AVMs instead of appraisals is also important, as it should make the process faster and further relieve lenders of appraisal rep and warrant risk. Analysts have heard anecdotal evidence that most putbacks are a result of misrepresentations in the appraisal and also income.
They were expecting the reduction in risk-based fees and the raising of (or potential removal of) the LTV ceiling, considering how relatively easy these changes would be to implement. Pools backed by greater than 125% LTV loans would not be REMIC eligible, but these loans can pooled in another prefix. Considering HARP paper's historically good convexity, these pools can see great secondary market demand, RBS analysts stated.
Meanwhile, Barclays Capital analysts released their initial analysis of the announcement's affect on MBS prepayments. They said that depending on the CPR assumption used for clean borrowers (these are loans that have been current for at least 12 months and that do not have MI), the impact would vary considerably.
But, analysts said that considering that the fastest one-year CPR ever for any major cohort was around 65 CPR, they feel that 50 CPR for one year is an appropriate assumption. Based on this, analysts projected that 5s and 5.5s will prepay at 42-44 CPR for a year, 6s should be 38-39 CPR and 6.5s should be 34-35 CPR. With the assumption that there will be no change to the HARP, these represent a 10-15 CPR rise for most 2006-2008 coupons for one year, analysts said.
Barclays analysts added that vintages and coupons that have lower FICO, higher updated LTV and a lower % of MI should prepay the fastest while 2005 though 2008 vintages should be most affected. They will also likely be a lower impact on seasoned vintages, analysts said, since the LTV is lower for most of the borrowers. For those and post-HARP vintages, there is some chance for prepay moderation for the higher-quality borrowers. This is with the originators focusing on refinancing the existing higher-rate loans from their books, considering the capacity constraints.
Barclays analysts looked at the speed effect assuming a realistic worst-case scenario. Specifically, they first excluded loans that were delinquent in the past 12 months. Of the remaining mortgages, they assumed that those without MI will prepay at a certain rate and those with MI will be a third slower. This offers the total voluntary speed, to which analysts then added the recent actual buyout CPR to get the total CPR.
BofA Merrill analysts gave their own view on the prepay impact of these changes, which they said can add up to increased speeds of 2-13 CPR. "We anticipate that the impact will be most keenly felt on higher coupons, where the reduced documentation requirements and shortened clean-pay hurdle will affect a greater percentage of the underlying borrowers."
They added that the upside risk in speeds is somewhat reduced by an additional restriction that was not seen in HARP's first version. The program is currently restricted to borrowers with an over 80% LTV. They said that loans under 80 LTV that have more options to refinance usually benefitted from the HARP's reduced requirements. By analysts' estimates, around 65% of all streamlined refinancings have an LTV that places them outside of the new limits.
Analysts Examine Market Impact
BofA Merrill analysts said that aside from the predictable knee-jerk widening, they think that today’s market response offers attractive levels to add higher-coupon MBS exposure. Analysts based this recommendation on three factors from today’s FHFA announcement.
The first is that the capacity and timing will still limit prepayments. September’s prepayment report offered enough evidence that originators are forced to prioritize loans to deal with capacity constraints. Even though the implementation delay will give originators some ramp-up time for their systems, a return to 2003 peak speeds still seems unlikely. Furthermore, no changes are expected to be implemented for at least 2-3 months.
Analysts said that the cake remains half-baked. According to them, most of today’s announcement is best classified as ‘big picture,’ with the finer points to be worked out in the near-term. The changes, they said, like the implementation of a fee instead of rep and warranty risk still needs more discussion. It still remains to be seen how quickly originators will forget the painful lessons financial crisis.
Analysts also said that burnout still exists. Even though hard to quantify, many small factors contribute to ‘burnout.’ While the HARP changes are meant to solve the problem of the low response rate, it is easy to see a less-than-anticipated response, specifically after the first responders are refinanced.
After Monday’s widening, BofA Merrill analysts said that the 5.5s and 6s offer a yield roughly 1% priced to the speed projections listed above. If in the longer term, speeds remain split between the base-case and the updated forecasts, the yield quickly increases, analysts said.
Giving full rep and warranty relief is still a potential worst-case scenario for higher coupons. However, analysts said that their "skepticism that originators will be given free rein leaves us to conclude that today’s price performance provides a buying opportunity."
