The current outlook for September prepayment speeds is for around a 10% increase overall with CPRs on 4s through moderately seasoned 5s increasing between 30% and 50%.
Meanwhile, credit-impaired coupons are expected to be mostly slower. The factors influencing speeds include a jump in refinancing activity as mortgage rates dropped. For August, 30-year fixed mortgage rates averaged 4.26% compared with 4.55% in July, while the Mortgage Bankers Association's (MBA) Refinance Index averaged 60% higher under the expanded survey coverage. A partially offsetting factor is a lower day count of 21 from 23 in August.
Currently, speeds are expected to peak in October/November, which is activity that is reported in November/December, with CPRs projected to increase less than 5% each month on average from September.
At this time, the projected peaks are expected to remain below last year's high. UBS analysts believe mortgage rates need to drop to 3.80% in order to reach the same speeds experienced in November 2010. Based on the MBA's expanded survey coverage to 75% of the retail market from 50%, UBS analyst Jeffrey Ho equates this to around 5750 on the Refinance Index.
Still Waiting for HARP Tweaks
The prepay outlook, however, is expected to be revised higher with peaks extended as mortgage rates decline with the Federal Reserve MBS purchases as well as some tweaking to the government's Home Affordable Refinance Program (HARP) that is expected to come from the Federal Housing Finance Agency (FHFA). Any changes to HARP, however, are expected to be limited based on a speech in mid-September from FHFA Acting Director Edward DeMarco.
Fairly clear was a gradual increase in g-fee pricing, which DeMarco said would "better reflect that which would be anticipated in a private, competitive market." He added that these increases "should be expected in 2012." He also noted that the purpose of HARP was not to mass-refinance everyone, but the program "was designed to address a particular segment of borrowers with loans guaranteed by the Enterprises."
He added that "in the meantime, continued declines in house prices and recent declines in mortgage interest rates to historic low levels suggest that more households could benefit from this program and, importantly, such refinances could reduce the Enterprises' credit risk." Under this premise, it would appear that expanding HARP to post-May 2009 originations is not likely. DeMarco even stated that most creditworthy borrowers outside of HARP's parameters should be able to refinance their mortgages through normal channels.
However, a selective expansion for 80+ LTV borrows is a possibility, said Credit Suisse analysts following DeMarco's speech. They noted that the further declines in home prices over this period have increased LTVs for borrowers who had original 80% LTVs, and so it is more difficult for them to refinance. Under this selection, Credit Suisse analysts said potentially up to 3 million borrowers would be able to refinance, although for various reasons, not all would be able to. They estimated that the impact would be around 5 CPR for 2010 4.5s and 2 CPR for 2010 5s.
DeMarco also said that the FHFA was trying to identify possible enhancements to HARP to help borrowers refinance including, loan-level pricing adjustments (LLPAs), reps and warranties, valuation requirements and portability of MI, as well as, barriers like the 125% LTV cap.
JPMorgan Securities analysts estimated in recent research that for the main frictions that have been discussed - the removal of the 125% LTV cap, reduced LLPAs, pulling through mortgage insurance, subordination of second liens and easing hurdles on Alt-A loans - the cumulative impact on speeds is less than 5 CPR for super premiums.
Nomura Securities analysts also noted just a limited increase on 5s through 6.5s (2008-2006 vintages) at 0.5% to 2.0% CPR under easing to LLPAs and LTV caps. More significant increases to speeds, they said, are seen of course with changes to reps and warranties such as allowing an automated appraisal versus an actual appraisal and no employment or income verification, and resolving MI issues such as expanding to >125% LTVs and making it easier for loans with pool insurance and lender-paid insurance to refi through HARP. Under this scenario, analysts said speeds could increase by around 10% to 12% CPR for 5s and 5.5s, 6% to 9% CPR for 6s, and by 5% to 6% CPR for 6.5s.
Surprising Muted Response
When comparing the stated mortgage rate from Freddie Mac's survey to the refi activity, there is some surprise at the muted response. Of course, there are the usual reasons influencing this: underwriting standards remain tight, home valuations poor, and the jobs and economic outlook very uncertain.
However, it turns out that many good credit-quality borrowers are not qualifying for that low a rate. Barclays Capital analysts recently pointed out that Freddie Mac's survey rate is aimed primarily at purchase loans and this has become more evident since 4Q09. Starting at that time, they said the gross WAC of a refinance loan is 10 basis points to 20 basis points higher than the gross weighted average coupon of a purchase loan after controlling for FICO, LTV and even points paid up front (purchase loans).
They added that looking at rates quoted by the four major lenders and controlling for term, loan size, FICO, LTV, geography, and upfront points revealed that almost all of them quoted rates on refis at 15-50 basis points higher than a purchase loan.
It is unclear why refinance loan rates are higher than purchase loans, but Barclays analysts said it could be related to increased put-back risks, which in turn are discouraging lenders from underwriting loans that were originated by another lender. Meanwhile, hedging purchase loans may be cheaper because of lower pull-through risk than hedging refinance loans.
