THE BASIS POINT

Current Thoughts Of Mortgage Traders

Investors in mortgage-backed securities are keenly interested in the prepayment speeds of new and old securities – why would someone pay a 3 point premium for a loan that is going to pay off in 4 months?

Analysts expect that prepayment speeds across the various non-agency (aka non-Fannie/Freddie) sectors should increase as mortgage rates continue to go lower. In particular, fixed-rate and longer resetting prime mortgages should be the most responsive to the lower rate environment as a relatively higher percentage of borrowers are “refinance-eligible” in those sectors.

In addition, some jumbo prime borrowers will have a significant refinance incentive for the first time as the mortgage rate reached historically low levels, and these borrowers should be most responsive to lower mortgage rates. Some borrowers have tried to fund high-balance loans prior to the October 1 loan limit date, and others are attracted to the overall level of jumbo rates with a 4% handle, low 3’s for a 5/1 ARM.

Since closing costs have increased, most now assume that a borrower currently needs at least a 75 basis point rate incentive to refinance – this population has more than doubled since the first quarter. Approximately 10% of outstanding prime fixed and longer-reset hybrid borrowers have become newly refinanceable from a rate perspective, and are refi-eligible according to CLTV and payment history criteria. One should expect that these borrowers should be most responsive to the lower rate environment, even with tighter underwriting (especially on 5/1 products).

The latest move by the Fed – to reinvest mortgage payoffs back into mortgages – has analysts racing back to their calculators. (I still have my 25-yr old 12-C!) In recent years the Fed has mostly been interested in owning conventional securities (Fannie & Freddie) and thus investors see less demand for Ginnie Mae production backed by FHA & VA loans. But a good percentage of GNMA’s come from new home sales, which show few signs of gearing up.

So if the supply is poor, and demand holds steady, the prices should do just fine.

And overall, even though the 10-yr yield has really dropped, and mortgage rates have as well, the MBA refinancing index has consistently surprised to the downside – folks just aren’t rushing in to refi.

Barclays notes that:

“While the main reasons for this benign refinancing activity have been well documented, notably, rep and warranty risk, tight underwriting standards, declining HPA, friction in the HARP program, and the absence of alternative credit in the non-agency market, two new factors have emerged, which we believe play an integral role in explaining the reduced refinancing activity. First, borrowers refinancing their home seem to be getting a higher mortgage rate than those purchasing a home. This behavior has been observed for most originators and is the most pronounced for the largest originators including Bank of America, JPMorgan Chase, and Wells Fargo. Second, even though primary-secondary spreads seem tighter this time, originator margins are at their widest, suggesting that originator capacity is still limited, and that borrowers are not obtaining as low a mortgage rate as they would if capacity were not an issue.”