New York - Panelists at the CPR & CDR Technologies 2004 Prepayment and Mortgage Credit Modeling and Strategy Conference held last week discussed whether new products currently proliferating in the mortgage sector - predominantly hybrid ARMs and IO loans - would change relative value relationships going forward. Discussions also centered on the accelerated prepayments on 2003 originated collateral. Participants shared their thoughts on what's driving discounts speeds to unchartered territory, and whether historical data is still relevant given the major structural changes in MBS land.
In the Round Table on Mortgage Backed Securities: Trends, Outlook and Strategies, researchers from the major Wall Street dealerships said that the movement to ARMs is not a borrower-driven phenomenon but it is a trend being pushed by lenders. After the strong employment report released in April caused rates to rise, there was a noticeable marketing shift by a number of large mortgage originators in order to maintain margins. These lenders started offering a matrix of hybrid ARM options even to borrowers who were mainly interested in a 30-year mortgage.
This shift in lender focus, according to participants, is here to stay. They also noted that the decision to move into a hybrid ARM or an IO loan is not determined by the shape of the yield curve. It is all about "extending affordability" to borrowers, analysts emphasized. Homeowners "for the first time have been given a tool to manager their liabilities," said a panelist. This is shown by the California example, where property values have skyrocketed. More and more borrowers are moving into IO loans to manage their monthly payments.
Analysts said that the proliferation of new products in the market place has a "profound impact on the existing universe" of traditional collateral relationships and prepayment behavior, including Ginnie Mae product versus its conventional counterparts and 15-year versus 30-year prepayments.
Moderator Deepak Narula, managing partner at Metacapital Management, presented data on FNMA and Gold 30-year discount prepayments in four different years: 1987, 1993, 1998, and 2003. The data showed that FNMA and Gold collateral exhibited similar prepayment behavior in the three previous years while dramatically rising in 2003. He asked panelists why 2003 originated discounts are prepaying so much faster compared to historical experience and named several possible explanations: housing turnover, home price appreciation, level of rates, slope of curve, proliferation of new products and defaults. He also questioned whether these speeds will stay fast or revert to the historical norm.
In a presentation by Rahul Parulekar, a director at Citigroup Global Markets, he attributed fast Fannie and GNMA discount speeds to home price appreciation Historical data points support this hypothesis. In 1999, 1998 6s were roughly two to three CPR faster versus 1993 6.5s in 1994. He noted that the 1993 to 1994 sell-off occurred during a weakening housing market. Meanwhile, 15-year discounts were faster versus 30-year discounts in the 1993 to 1994 period, and on par with 30-year discounts in 1999 to 2000. Currently, 15-year discounts are paying slower than 30-year discounts.
Though some panelists were leaning toward the theory that the fast prepayments on 2003 collateral are caused by embedded seasoning, others disagreed. Some of the participants said that borrowers who did not have a longer tenure in mind should have refinanced into an ARM instead of a 30-year fixed, this is why seasoning might be less of a factor.
Panelists said that an interesting development in the market has to do with high LTV loans - which were previously prepaying slower compared to lower LTV loans because of factors such as delays in the appraisal process. In his presentation, Akiva Dickstein, a managing director at Merrill Lynch, said that lately the reverse has been true. High LTV pools have been prepaying faster versus low LTV ones, suggesting a refinancing component. Participants said that it is possible that borrowers who are more strapped for cash have a higher propensity to do a cash out or move into a hybrid ARM or an IO loan, thus increasing speeds on the sector.
In terms of GNMA speeds being faster than their conventional counterparts, panelists noted the increase in defaults in the sector are driving the accelerated speeds. However, others said that since GNMA market share has diminished so much, especially in light of subprime lenders targeting traditional GNMA borrowers, delinquencies might just appear to be higher because of the smaller number of borrowers, and it is not necessarily because the borrowers are defaulting more frequently.
Traditionally GNMA borrowers, since they have lower down payments, take longer to accumulate equity. This effect has been minimized by home price appreciation. Other panelists, in comparing GNMA prepayments with high LTV conventionals, noted that GNMAs would probably be easier to refinance than off-the-run conventionals.
There was also a lot of discussion on why 2003 vintage discount 15-year prepayments are slower than corresponding 30-year prepayments. Analysts said that 15-year borrowers typically are not trying to lower their monthly payments, unlike those with 30-year mortgages who have a greater propensity to move into alternative products like hybrid ARMs.
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