The major contributors to prepayments in 2010 are expected to be involuntary.
These would result either from buyouts due to loan modifications in the case of the GSEs or from servicers related to GNMA delinquencies.
However, fragile housing market conditions and the conclusion of the Federal Reserve's MBS purchase program suggest the GSEs might will adopt a more orderly pace in their loan modification efforts than initially thought, while FHA changes as well as recent strong servicer buyouts should contribute to a temporary pause in the GNMA sector.
Higher coupons are at risk for accelerated buyouts related to various factors, including the GSEs' adoption of FAS 166, the increase of the portfolio caps and the removal of the funding caps.
However, most mortgage analysts are not expecting a massive buyout to occur in the near term, as it would cause significant turbulence to the mortgage market and increase borrowing costs for homeowners. Mortgage rates are already expected to increase modestly following the Fed's exit from MBS purchases.
JPMorgan Securities analysts believe it is probable that the pace of buyouts will be spread out over some period of time, possibly 6 or even 12 months. They warned, however, that investors should stay vigilant about signs that this activity could be picking up. A signal that analysts pointed to was an increase in debt issuance from the GSEs. They noted that when the GSEs buy out a delinquent loan, it has to be funded.
Speeds on 30-year GNMAs are projected to plunge in aggregate in January, with relatively uniform declines across the stack. Active servicer buyout activity in GNMAs in recent months from Citi, Wells Fargo, Countrywide and Bank of America pools suggests a temporary pause, which should lead to a significant decline in speeds on aggregate in January. Barclays Capital analysts said in a recent report that it will take time to rebuild the delinquency pipelines, and, as such, they expect GNMA prepayments will be relatively muted for the next three months.
Recently, the Federal Housing Administration (FHA) announced policy changes it said were designed to strengthen the FHA's capital reserves. 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 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%. These last two changes will be posted in the Federal Register for comment and would go into effect in early summer. Overall, the changes are seen as having just a slight decrease on prepayments.
Barclays analysts believe the changes lead to a slight decrease in the refinancing incentive for both existing and new GNMA loans. However, it's the 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-that offer a bigger reduction in involuntary buyout risks.
"All in all, we expect new origination GNMA pools to have faster voluntary prepayments, fewer buyouts and worse convexity than earlier vintages," Barclays analysts said.
BNP Paribas analysts agreed, adding that there shouldn't be an "outsized impact" on 6s and 6.5s, while speeds on 5s and 5.5s could see some slowing.
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