Although the Fed agency MBS purchase program could be considered successful — with mortgage spreads to Treasuries approaching their narrowest levels in this past month  and housing affordability reaching record levels— JPMorgan Securities analysts said that there are few borrowers that have actually refinanced into the historically attractive rates that are available.

Analysts said that even before last Wednesday’s sell-off, refinancing activity was showing signs of decline. Last week’s application index (week ending 5/22) dropped 20% to under 4,000. Additionally,  before the sell-off,  the 30-year mortgage universe had 100 to 125 basis point rate incentive, however,  the index seems to have “burnt out” just after six weeks. This is despite primary/secondary rates narrowing.
 
The Obama administration has also helped agency borrowers to remove or reduce appraisal, PMI and underwriting requirements to increase pull-through rates and prepayment speeds. Despite these,  prepayment rates are roughly 10 CPR under what JPMorgan analysts expected the market to produce.

JPMorgan said that the Federal Reserve spends $100 billion in agency MBS purchases to keep  rates low, which have helped bring down the mortgage rate and spurred around 10 CPR of incremental refinancing across the market from the start of 2009. However, the analysts said that the cost of refinancing has remained at  $1500 to $2,000 per loan, which has served as an impediment to refinancing. Reducing this cost, according to analysts, could be just as important as bringing down the mortgage rates.

How then can the Fed program be made more efficient? Even with two million more borrowers able to refinance as a result of this program, the market still lags. To improve, there has to be a way to increase the denominator, which means the number of borrowers that get refinanced.

According to JPMorgan, there are three things that need to be done to increase the number of refinancings. These are: for Fannie Mae to remove all LLPA g-fees; for Freddie Mac to open a streamlined refinance channel to all originators; and for the government and lenders to invest in advertising/PR to reach borrowers and inform them of the rates available to them.

Analysts expect the Fed to follow through with purchasing $1.25 trillion of MBS through the end of the year. These steady purchases has driven spread steadily tighter each week. The higher mortgage rates have also reduced gross issuance and the subdued Refinance index also helps  drive spreads in. But in the third or early fourth quarter, investors are likely going to price in the eventual end of the Fed program and as early as October, forward roll prices will indicate how mortgages are going to be priced in January. These will put pressure on spreads. Until then, analysts expect spreads to tighten, although with some volatility.

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