Analysts See Refinancing Rate Slowing Down

Several prepayment trends in the discount mortgage-backed securities sector are likely to reverse in the coming months as the housing sector continues to cool down, according to Bear Stearns & Co.

Writing in the February issue of Short-Term Prepayment Estimates, analysts Dale Westhoff and V. S. Srinivasan noted that less than 12% of the mortgage universe was still refinanceable around the beginning of the year, with 75% at or below the 5.5% coupon.

Over the past five years, prepayment behavior in the discount sector has in some ways been "turned upside down" by surging home price appreciation, they said.

"With a clear inflection point reached in the housing cycle, we expect many of these relationships to begin a reversal process creating some of the best trading opportunities in 2006," the Bear Stearns analysts said.

For example, speeds on discount MBS pools backed by loans with high loan-to-value ratios are likely to slow significantly, the analysts predicted.

High-LTV discount pools have been prepaying faster than usual in recent years, in part because they are backed by financially weaker borrowers more likely to tap their home equity through cash-out refinancings when home prices rise, according to the analysts.

In addition, rapid home price appreciation has allowed many high-LTV borrowers to eliminate mortgage insurance payments ahead of schedule by refinancing and thereby reducing LTVs to 75% or below, which permits them to cancel the MI, they said.

"In a slowing housing market, MI-induced prepayments are likely to disappear quickly, while the slowdown in cash-out refinancing will be proportional to the slowdown in the rate of home price appreciation," the analysts said.

Another predicted trend reversal is that discount speeds on new originations will converge across geographic regions. Much of the existing disparity stems from innovations in states like California, where so-called affordability products (such as interest-only loans and payment-option ARMs) have been widely marketed.

"A slowing housing market will slow down the rate of equity buildup and curtail innovation in the mortgage market as underwriting standards tighten," the Bear Stearns analysts forecast. This should lead to "significant convergence" in discount speeds across geographic regions, they said.

In other prepayment-related news, subprime residential MBS speeds held steady or declined slightly in December, probably as a result of seasonal deceleration, according to Friedman, Billings, Ramsey & Co.

"We saw no change in mortgage rates during December's refinance window," said FBR research analysts Michael D. Youngblood, Jason Hu and Aleksandra Cvijetinovic in a Jan. 27 report on subprime MBS performance. "However, over the same period, the MBA Refinance Index fell by 44% from 1,862.8 on Oct. 28 to 1,039 on Nov. 25."

The analysts predicted that the slowdown in speeds would continue in January based on the rise in mortgage rates and "weaker seasonal factors."

Prepayments for subprime mortgages in vintage 2003 fixed-rate RMBS fell 4.6% to a constant prepayment rate of 37.0 CPR, while speeds for the 2004 vintage fell 5.7% to 29.9 CPR, according to FBR.

Breaking the pattern were mortgages in 2005 RMBS, which recorded a small prepayment increase of 2.2% to 27.6 CPR. The rise was spurred chiefly by 7.5s and 8.0s, whose speeds accelerated by 22.5% and 58.8%, respectively, FBR reported.

The vintage 2005 8.0s "continue to display the most volatility month over month due to greater sensitivity to changes in mortgage rates," the FBR analysts said. "Since October, we have observed pendulum swings in prepayments among this coupon cohort."

Turning to subprime RMBS backed by adjustable-rate mortgages, the analysts reported that speeds slowed by 3.2%, to 51.6 CPR, among vintage 2003 securities, while holding steady at 45.0 CPR for the 2004 vintage. Among 2005 RMBS, prepayments declined 2.4%, to 28.5 CPR.

Defying the trend were prepayment rates for vintage 2004 8.0s, which climbed 27.3% (to 68.6 CPR), and for vintage 2005 8.5s, which rose 21.4% (to 48.7 CPR).

"The faster speeds reflect the heightened refinance activity among adjustable-rate loans near the mortgage rate adjustment period in month 12 and month 24," the analysts said.

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