Last week Fannie Mae and Freddie Mac announced new conforming loan limits for next year would be increased 16% to $417,000 from $359,650 - the largest annual rise on record in both percentage and absolute dollar terms. The limit, determined by the Office of Federal Housing Enterprise, is based on average federal home price data.
David Montano, head of mortgage research at JPMorgan Securities, said that while expected, the impact of the increase would likely be very substantial, especially considering slowing home price appreciation. He added that agency securities would be forming a larger share of the mortgage market with loan limits growing faster than median home prices.
Rising loan sizes in early 2006 will add roughly three to five basis points in option cost to TBA FNMA 6s, Montano said. FNMA 6s are most impacted by the change in the agency loan limit as it becomes the production coupon. The current average loan size of 6s is very small as it has not been a prime production coupon for a few years. Montano is currently assuming a $160,000 TBA rising to $250,000 early next year.
In a related report, Bear Stearns analysts said that change would have the biggest impact on Jumbo collateral.
The limit increase would make a significant percentage of current Jumbo mortgages outstanding - 15.2% - eligible for an agency mortgage next year, reported Bear analysts. This means the total balance of Jumbo loans at or below the 2006 agency limit would rise to 34.8% of total outstandings. Fixed-rate Jumbos would be feeling the brunt of the change compared to ARM product. For fixed-rate loans, exposure more than doubles, said Bear Stearns, as 15.3% are under the 2005 agency limit, and an added 19.9% will fall under next year's limit.
In ARMs, Bear Stearns said exposure to the 2005 limit is already comparatively high - 22.2% - further rising 12.4% next year. This would mean that after the beginning of 2006, the total exposure of fixed-rate and ARM portions in Jumbos will be almost comparable, with about 35% of both sectors being at or below the 2006 agency loan size limit, said Bear researchers.
Bear Stearns analysts added that compared to Jumbo collateral, the effect in Alt-A is quite small. To start, most Alt-A vintages mostly currently fall under the 2005 agency limit, particularly for fixed-rates. The net change for Alt-As - both in fixed-rate and ARMs - is an added 8.6% of currently outstanding loans that will be at or below next year's agency limit.
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