In his Jan. 24 State of the Union address, President Obama stated that he was sending to Congress a plan that gives responsible homeowners the chance to refinance into historically low rates. He said that through this prospective program, homeowners can save roughly $3,000 per year on their mortgage.

"No more red tape. No more runaround from the banks," he said. "A small fee on the largest financial institutions will ensure that it won't add to the deficit and will give those banks that were rescued by taxpayers a chance to repay a deficit of trust."

With details yet to come, mortgage market participants were left to speculate on the potential impact to MBS. The general consensus among Street analysts was that anything that involved the legislative process has a very low chance of getting through given Congress' divisive makeup. There was also some speculation that the proposed refinancing program is targeted to help non-agency borrowers to refinance into Federal Housing Administration (FHA) mortgages.

Changes to help underwater borrowers refinance that could be made without congressional approval, however, such as further easing of Home Affordable Refinance Program (HARP), were viewed as having a better chance.

This includes such things as further streamlining, eliminating loan-level price adjustments or further reducing put-back risk.

Nomura Securities analysts also said that a settlement between banks and attorneys general regarding robo-signing can be used toward writing down principal and refinancing non-agency MBS into FHA loans.

If the administration successfully expands credit-impaired refinancings into a low mortgage rate, Barclays Capital analysts said it will need help from the Federal Reserve to buy these MBS, as traditional buyers like banks could potentially have significant asset liability management issues, depending on the term and rate.

As expected, the Fed did not address quantitative easing 3 in its Federal Open Market Committee (FOMC) statement.

However, it also did not acknowledge any of the recent improvement in some of the housing data.

The FOMC's view of the housing market "remains depressed." In addition to the president's housing push, this should keep odds - which are estimated at between 30% and 50% - firm in regards to QE3 occurring later this year.

In the meantime, until more details emerge, higher coupons are likely to remain sensitive to the headlines. However, Credit Suisse analysts believe high coupons are already pricing in a significant policy risk premium, and they recommend legging in on any meaningful cheapening.


Recent Jump in Refis

With mortgage rates holding below 4.0% for seven straight weeks and at new record lows (3.88%), mortgage refinancing activity is up 17% on average so far in January from December. In fact, in the week ending Jan. 13, the Mortgage Bankers Association's (MBA) Refinance Index surged 26.4% to 4500.6 - its highest level since mid-August 2011's high of 4866.7.

The jump was attributed primarily to pent-up demand following the yearend holiday distractions as well as very attractive mortgage rate levels. Prepayment response from the gain is expected to be primarily reflected in the March report released in April, with a slight impact seen in the February report.

In the weeks and months ahead, refinancing activity should also begin to be affected by the looming increase in g-fees scheduled for April 1 and by HARP 2.0.

On the former, Nomura analysts said that they expect the g-fee increase to be reflected in mortgage applications in February. Meanwhile, Morgan Stanley analysts have noted that some originators are requiring correspondents to close loans by Feb. 29 to avoid paying the new g-fees. "Thus, there is likely to be a rush to close loan applications by Feb 29," they stated.

Meanwhile, HARP 2.0 application activity is anticipated to become more noticeable beginning in March as Fannie Mae's DU will be updated for the HARP changes. Bank of America Merrill Lynch analysts said two indicators that might help determine when the Refinance Index has shifted from normal refinancing to HARP-refis are the average loan size and the split between government and conventional mortgages.

On the latter, the MBA's Refinance Index consists of two sub-components: conventional and Ginnie Mae. A pickup in HARP activity should show increased conventional activity versus GNMAs.

In the week ending Jan. 13, Ginnie Mae refinancinghere is likely to be a rush to close loan applications by Feb 29,s rose 28%, while conventionals increased to nearly as much at 26%, BofA Merrill analysts stated. This indicates that HARP activity had no influence on the jump in refinance applications.

BofA Merrill analysts also said that another way to find out about HARP activity is looking at loan-level data and seeing the characteristics of the loans being refinanced.

They pointed out that in May 2011 the average current LTV (using Freddie Mac data) of loans that prepaid was 83, while last fall when mortgage rates dropped sharply the current LTV of the prepaid loans dropped to 73.

Meanwhile, Deutsche Bank Securities analysts cited the increase in mortgage rates this week in response to originator capacity issues as a possible sign of a pickup in HARP applications. In a recent Mbstrader comment, they said that JPMorgan Chase had the largest rate increase at 1/4% to 4.375% with several others raising their best posted rate by 1/8%.

"The increase in rates comes after a sharp spike in the MBA Refinancing Index in the week ending Jan. 13, suggesting that capacity issues may be a consideration, especially for Chase," they said. "This could be a first sign that originators are seeing a surge in applications from a retooled HARP program."

Prepayment speeds are currently projected to slow around 2% to 3% on average for 30-year conventionals and GNMAs and 15-year FNMAs. In 30-year conventionals, 5% and lower coupons are expected to record larger percentage declines versus higher coupons with 6s and above projected to flat to slightly faster on average from December.

The longer processing times associated with the credit-impaired coupons is an influence on the fuller coupons.

The other factors affecting CPRs include a lower number of collection days at 20 from 21, while refinance activity picked up a slight 4.0% on average in December as mortgage rates slipped to an average of 3.95% from 3.99%.

Paydowns are estimated at $108 billion compared to $111 billion in December. Currently, month-to-date gross issuance stands at $70 billion. The January report will be released in on Feb. 6.

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