Although refinancing has continued to be muted given all the post-downturn market conditions that counteract today’s rates, reaction to recent prepayment reports show some speeds are still surprising to the upside in some cases.

Derek Chen, a researcher at Barclays Capital, said in a Sept. 9 interview that he still thinks the best those looking for a pickup in refinancing can hope for is a mini-refi wave in a historical context.

But while the overall level of refis is expected to remain pretty low, the “tiering” in terms of relative prepayment spikes in some areas is going to be massive due to factors such as whether loans are eligible for the government Home Affordable Refinance Program (HARP) or not, for example, he said.

Some of this is proving to be a question of timing.

Take a ramp-up in lower-coupon MBS (those with coupons of 4.5% and 5%) that surprised Barclays and some others in the most recent prepayment report, for example.

This followed a surprise to the downside in the previous prepayment report, suggesting there was a backlog of loans as originators geared up for a surge in demand, Chen said.

He said this means the surge was likely a one-time event and that the next increase in speeds seen will be of a smaller magnitude.

While some in the MBS market appeared surprised by the spike in voluntary refis on lower coupons, Mahesh Swaminathan, a researcher at Credit Suisse, said in an interview that this was in line with his firm’s view that these coupons have been very sensitive.

However, he said faster-than-expected 2008 speeds were surprising to both his firm and others.
According to a Sept. 9 Credit Suisse report, traditional factors like loan balance and note rates largely explain the speed spike in the 2008 vintage compared to 2009.

The report projects that the latter will catch up in a further rally, noting that this counters the argument by some that the 2009 vintage will remain slow due to a higher HARP impact on the 2008 vintage.

Swaminathan said he believes the HARP does play a role but the two vintages’ convergence is just a question of timing and refinancing incentive. When adjusted for the latter, the convergence appears to be playing out, he said.

As Credit Suisse noted, although lower coupons have seen prepayment spikes, higher coupon speeds remain tame. Despite this, investors remain wary of a government-driven “auto-refi” spike.

Credit Suisse has been in the camp of those who think this is highly unlikely but the firm continues to find that relatively high percentages of investors are pricing the possibility into the market.

The firm has defined such an auto-refi plan in terms of its impact on the prepayment speeds of FNMA 6s and measured its potential severity as one would measure the severity of a hurricane.
In its most recent analysis, it found that the market is pricing in a 44% chance of a category three auto-refi and a 100% chance of a category one after 12 months.

Economic signals that could determine which direction rates head going forward remained mixed at press time but it is likely they will remain relatively low through at least the end of the year, Freddie Mac chief economist Frank Nothaft said in a recent interview.

Swaminathan said that the latest prepayment report shows borrowers with the lowest loan-to-value ratios and the best credit scores are able and very actively refinancing as expected and researchers expect to see more of this.

Credit quality does appear to continue to be improved in recent vintage loans, and interestingly Moody’s Investors Service has said new U.S. rules on originator compensation slated to go into effect next year could add more momentum to this trend.

Moody’s believes the restrictions on compensation will lower defaults because they prohibit, among other things, financial incentives to charge higher rates when borrowers’ risk profiles call for lower ones.

Moody’s also sees as contributing to this the Safe Harbor available to orginators when they disclose to borrowers: the lowest interest rate the borrowers ask and qualify for, the loan that minimizes the originators’ points and fees, and the loan with the lowest rate, barring any that have features that put additional constraints on consumers’ finances such as negative amortization or prepayment penalties.

However, Moody’s also noted there are some uncertainties that remain about the consequences for securitized loans originated after the planned implementation date in April 2011. As a result, Moody’s said it is looking into whether there would be any penalties for those that did not comply that could affect the securitization trust.

Among other legal issues Moody’s Investors Service has been looking at that could shape the future of the mortgage-related capital markets is a draft of a new law by the Bank of Spain that will call for issuers in that country to provide more data on the collateral from asset pools backing covered bonds.

Also adding to compliance requirements for some mortgage-related securities is Australia, which is requiring issuers of RMBS to hold more capital when they retain junior tranches of transactions, Moody’s noted.

In this case, Moody’s believes there will be an increase in the cost of RMBS funding, something it sees as a credit negative for the country’s smaller lenders.

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