With interest rates low and federal housing initiatives in full force, the July prepayment report, scheduled for release in August, is expected to show an increase in speeds.
Mortgage rates are a factor in the expected gains in the lower coupons, while government policy actions through programs, including the Home Affordable Refinance Program (HARP), are affecting fuller coupon conventionals. Also affecting higher-coupon GNMAs is the June 11 reduction in Federal Housing Administration mortgage insurance premiums on streamlined refinances for loans made before June 2009.
The bigger prepayment impact is on the less seasoned and lower-coupon credit-eligible cohorts. Thirty-year fixed mortgage rates averaged a record low 3.68% in June, down 12 basis points from the prior month, which led to an 18% average jump in refinancing activity.
As a result, prepayment speeds on 30-year FNMA 2010 and 2011 3.5s and 4.0s are projected to have surged between 25% and 35% in July. Meanwhile, speeds on the HARP-eligible 5.5s through 6.5s appear to be nearing their peaks; they are expected to have increased by just 1%-2% on average in July.
JPMorgan Securities analysts expect that speeds will hover around these levels through the end of the year as some of the small-to-mid-sized lenders, not to mention Bank of America, are still ramping up their HARP programs.
Deutsche Bank Securities analysts also believe that, while speeds are near their peaks, they are probably not going to experience much of a slowdown over the next three months either. This is partly because mortgage servicers JPMorgan Chase and Wells Fargo continue to show a steady pace of HARP refinancing.
This trend of increased activity is expected to continue "until and unless we see signs of a slowdown from these two lenders," they said in a research report. The analysts also expect prepayments on higher coupons to be "sticky."
The August report, which will be released in September, is expected to have speeds around 10% higher in lower coupons, while prepayments on higher HARP coupons are projected to increase 5%.
The lower rates and increased refinancing activity as well as a higher number of collection days in August, which will be at 23 from 21 in July, are all factors in the expected increase. Meanwhile, September prepayments are expected to fall around 10% across the coupon stack as the day count drops to 19.
Some impact from the reduction in mortgage insurance premiums for loans made before June 2009 appeared in June prepayments, with GNMA I 2009 and 2008 vintage speeds jumping 29% and 37%, respectively, versus a projection of 4% and -1%. July speeds should experience the biggest impact, with 2009 and older vintages projected to increase between 30% and 60% on average.
This is indicated by the surge in the Mortgage Bankers Association's Government Refinance Index, which hit a record high of 8872 in mid-June from under 3000 in late May. While the index has since declined, it remains elevated at over 5000 on average so far in July, with speeds expected to hold flat to slightly higher in August.
Lower mortgage rates will also contribute to elevated speeds on 2010 and 2011 3.5s and 4.0s, which are seen increasing 10%-20% in July and by a similar amount in August. In addition, BofA delinquency buyouts should also be a noticeable influence on the belly coupons and extend to 6% and 6.5% speeds, which are anticipated to increase between 15% and 20%.
QE 3 Possibilities
Despite the expected higher levels of prepayments, mortgage-backed analysts are maintaining a positive outlook on the sector, as current indicators suggest that the probability of a third round of quantitative easing by the Federal Reserve is still likely.
Credit Suisse analysts have the probability of a QE3 at roughly 80% during the week of July 23, up from the mid-70% area in the prior week and mid-60%s in the week before that.
The lackluster performance in the lower coupons that occurred during the week of July 23 "suggests that the market is unwilling to aggressively bake-in an increase in QE3 probability" beyond its current level, they said.
According to BNP Paribas analysts, employment indicators such as payrolls will probably reinforce the need for QE3.
They said that as origination has moved from 3.5s into 3s, so have Fed purchases (see chart on this page).
Investors are optomistic that this event is going to happen. In a recnt JPMorgan survey, close to 80% of mortgage investors expect QE3 in MBS to happen at some point with over half expecting it to be announced by the September Fed meeting.
Meanwhile, as of July 29, Banx.com reported that although the average mortgage rate is 3.60%, the best mortgage rate is 3.38%, a difference that seems to have been more heightened recently.
BNP analysts said this differential implies that the best borrowers, including those with a 3.5% rate, have a much higher rate incentive than what is suggested by the average rate alone.
They projected that for the July prepayment report 3.5% speeds should surprise on the upside, while 4s should manifest relatively smaller increases because of burnout.