Rate Cuts, Teaser Freeze and Underwriting Reform

You can forgive the mortgage industry for feeling a little less merry than usual this holiday season. Just about everyone, from brokers to lenders to secondary market conduits to investors and servicers, is feeling some of the industry's pain.

On the bright side, it's probably a better time to be working in the servicing end of the business than the origination end. Rising delinquencies may be a headache, but at least servicing operations are hiring rather than laying off employees.

And while portfolio runoff and servicing impairment haven't been hot topics lately, they might rear its head again as big loan servicers start to compile their year-end financial reports.

And the tightening of underwriting standards has had a bit of a silver lining for servicing managers: loans are not running off as quickly as they once did, because fewer borrowers are able to refinance. Because of slower prepayment speeds, some lenders reported hedging "outperformance" in the third quarter, as financial instruments used to hedge interest rate risk rose in value more than servicing rights lost value.

Then again, that might be little consolation to lenders that had to report big increases in loss reserves due to the weak housing market.

Nonetheless, that underwriting-driven slowdown in prepay speeds could be good news going forward, because long-term interest rates have edged downward again, leaving some loans "cuspy" from a refinancing perspective. While most lenders enjoy historically low weighted-average coupons on their portfolios today, that doesn't mean the remaining chunk of loans carrying note rates in the high sixes or low sevens will stay on the books forever. According to Freddie Mac, the average 30-year mortgage rate dipped to 6.1% at the end of November, it's lowest level since October 2005. Data from the Mortgage Bankers Association showed long-term mortgage rates dipping even lower in early December. Even more tellingly, the refinancing share of home loan applications jumped to 56%, putting it squarely into "refi boom" territory by historical standards. The problem with calling it a boom is that it doesn't feel like a boom when housing markets are in a slowdown and, because of weak home purchase lending, total loan volume is dropping. You don't hear many loan originators complaining about capacity problems in this refi boomlet.

And that, mind you, was before the Federal Reserve Board had a chance to consider lowering short-term rates even further at its December meeting. While MSN went to press before the Fed's meeting, many economists and Wall Street seemed to expect the Fed to take action.

The bottom line: with rates slipping, more and more borrowers are going to be thinking about refinancing their home loans again. While that may help some of them manage payment problems, it doesn't bode well for the value of mortgage servicing rights.

The Bush administration's plan to freeze teaser rates in place on more than one million ARM loans for five years will help some borrowers, but it's no panacea. For some, it may just delay the day of reckoning.

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