Analysts Anticipate Higher Prepayment Activity for May

Analysts were predicting an increase in May prepayment rates for 30-year mortgages in Fannie Mae and Freddie Mac mortgage-backed securities, citing a higher number of business days and seasonal housing turnover.

In the Mortgage Strategist, UBS analysts were forecasting that speeds would rise about 7%-10% in May. (This column was written before the release of agency prepayment rates for May.)

"Speeds on discount coupons should rise slightly more than 7%-10%, while premium coupons will increase less (seasonality has little impact on premium speeds)," the UBS analysts said. "New premium coupons backed by alt-A mortgages could continue to prepay slower than usual, due to tighter underwriting guides and limited [home price appreciation]."

Analysts at Bear Stearns & Co. were also projecting faster MBS speeds in May, though they foresaw a less robust 5%-7% increase.

"Against a backdrop of continued weakness in the housing sector and tighter lending standards, we expect prepayment speeds to remain significantly slower than the 2006 experience," the Bear Stearns analysts wrote in the May 7 Prepayment Commentary. "Controlled for seasoning and relative coupons, prepayments in 2007 are already running 20% slower than in 2006. This trend will likely intensify as the new, more conservative underwriting standards are fully absorbed by the market."

Meanwhile, Credit Suisse published an analysis of reduced-servicing mortgage pools, arguing that pools with a smaller proportion of third-party-originated loans are more appealing to investors because they offer an attractive "prepayment profile."

Such pools experience slower prepayment speeds than to-be-announced coupons, and have comparable (or slightly slower) prepayment records than TBA pools even after adjusting for loan balance, age and rate incentives, according to Credit Suisse analysts.

"This is notable given that the coupon on a reduced servicing pool is typically 50bp higher than a TBA coupon with the same note rate," they said.

In other prepayment-related news, Fairway Independent Mortgage Co., a mortgage banker based in Sun Prairie, Wis., recently made a new policy that prohibits any loan officer from charging a prepayment penalty longer than one year on any payment-option ARM product.

"This new policy demonstrates Fairway Independent's commitment to the borrower in times when mortgage companies have been accused of putting their interests before those of customers," the company said.

Fairway noted that prepayment penalties typically enable originators to earn higher fees on a per-loan basis. "Generally speaking, the longer the prepayment penalty for the borrower, the higher the fee paid by the lender to the originating party," Fairway said, adding that such policies offer "absolutely no benefit to the customer."

Meanwhile, senior Republicans on the House Financial Services Committee recently expressed concern about stated-income loans with high loan-to-value ratios and prepayment penalties.

The lawmakers - Rep. Spencer Bachus (Ala.), Rep. Paul Gillmor (Ohio) and Rep. Judy Biggert (Ill.) - wrote a letter to federal banking regulators supporting efforts by the comptroller of the currency to include restrictions on such loans in federal subprime guidance.

The legislators conceded that there should be a "small niche" for stated-income loans but maintained that they increase the risks of default.

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