In the big picture, while investors counting on muted prepayments today are perhaps not completely ignoring falling rates, they do appear to be less worried about them than government policies.
Dale Westhoff, a veteran prepay expert who somewhat recently returned to the business as a managing director at Credit Suisse, said at a company press briefing last week it is striking “how insensitive prepayments have become.”
“There’s no period to compare,” he added in an interview with ASR sister publication National Mortgage News.
As a result, “Things are trading at much longer durations,” Westhoff said.
While the recent prepayment scenario has been unprecedented, durations have been close to what is modeled, he added, when asked about them.
As a result of the market’s relatively prepayment insensitivity, some investors have been taking on prepay risk. “That’s a risk a lot of investors are willing to take on right now,” Westhoff, who is CS’s global head of structured products, said.
“If there is any credit or equity weakness in a borrower, forget about it,” he added, referring to what he said is the fact that the probability that borrowers in these categories can refinance their loans has gone down to an unprecedented level.
The No. 1 risk to the prepayment insensitivity in the market that investors have told Credit Suisse about is policy rather than rates, Westhoff said.
The concern heard from some investors has been that the government might expand, say, the Home Affordable Refinance Program (HARP), Mahesh Swaminathan, Credit Suisse managing director and head of MBS strategy, told attendees at the press briefing. Their thinking is that refinancing a larger group of credit sensitive borrowers could be seen as a way to, for example, reduce Fannie Mae and Freddie Mac’s credit risk, Westhoff said.
However, currently the HARP program’s requirements are so relatively restrictive most investors do not appear worried about it, he confirmed.
He said that if rates rise and the main driver of prepayments becomes housing turnover, clearly prepays will become even more primarily linked to government policy in the mortgaged home market.
The GSEs’ massive REO portfolios effectively give the government “a throttle on home prices,” he said.
Thus, policy could be used to address housing supply.
Controlled disposition of sales would probably be the best way to do this, Westhoff added.
Ultimately, “There is no silver bullet” for the market’s current housing woes, he said.
Not only does the prepayment scenario in today’s market continue to be unprecedented, analyses of delinquencies and foreclosure pipelines still are.
“No one has ever seen something like this before. It’s out of sample,” he said.
“Sometimes I think people forget about that,” Westhoff said, adding that he thinks it is something that should be kept in mind when it comes to sizing up home price projections.
Confidence in home price projections “needs to be wider,” he said.
While such complications continue to challenge the return of the securitized nonagency residential mortgage market, Westhoff said he has seen some hopeful signs. He noted that among these was REIT Two Harbors Investment Corp.’s report last week that it is closing a warehouse facility in partnership with Barclays Bank to aggregate loans with the goal of issuing a $250 million jumbo securitization.
“The REITs are going to play an interesting role in the new issue market,” he said. “Don’t expect it to be dramatic,” Westhoff said, when asked about this. “It’s going to be incremental.”