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Rejections a Question as Refi Volume Rises

Expectations are growing that the Federal Reserve's rate cuts have set the stage for a refinancing boom that could bolster struggling mortgage companies and help a lot of borrowers get into safer and lower-cost mortgages.

Mortgage refinancing applications have surged in recent weeks, according to a Mortgage Bankers Association survey. But tighter underwriting standards and falling house prices could lead to an unprecedented level of rejections.

This has lenders on edge as they wait for the appraisal reports. "Business is booming on refis but they are all wondering what the values are going to be. That is the wildcard," said mortgage banking consultant Brian Chappelle.

Lenders also are concerned the American consumer may be tapped out, he said, and don't have the savings to pay down the mortgage if the appraisal comes in low. Mr. Chappelle is a founder of Potomac Partners in Washington.

Terry Couto, a founding partner at Newbold Advisors, says there are a lot of people that have been in their homes for a long time and are current on the mortgages. And they are going to have no problem refinancing.

However, this refi wave is "really going to refinance the good credits," he said. The delinquent subprime borrowers can't refinance into another subprime loan any more and they will be lucky to get into a Federal Housing Administration loan.

"Some bad loans are going to get modified, of course. But a lot of bad loans are just going to go bad," he said. Newbold Advisors is based in Palm Harbor, Fla.

Researchers at Friedman Billings Ramsey recently reported that defaults on securitized subprime mortgage loans hit 21.3% in November, up 188 basis points from the previous month.

The default rate on these non-agency loans has accelerated "briskly" since August, according to the "Structured Finance Insights" report, which shows the default rate on subprime mortgages has doubled since November 2006. (The default rate includes loans 90 days or more past due, in foreclosure and real estate-owned.)

FBR managing director Michael Youngblood attributes this rapidly deteriorating performance to falling house prices and weakening labor market conditions that are "characteristic" of a recession.

Nevertheless, Mr. Youngblood insists there are plenty of qualified borrowers that can refinance, including two-thirds of subprime borrowers that are still current. He expects the 2008 refinancing wave will match the wave of 2001.

"We expect the current surge in refinancing to persist as long as agency and non-agency mortgage rates remain below the critical thresholds of 6% and 7%, respectfully," he said.

He also noted that banks and servicers have an incentive to refinance mortgages as opposed to modifying loans due to the accounting rules on troubled debt restructurings.

Portfolio lenders and investors in mortgage-backed securities have to recognize a loss on modifications even if the interest rate is frozen at the current rate or it is the same rate lenders are making on new loans.

"I think the possibility of having to reclassify a modified loan as a TDR will impel the public servicers to refinance these puppies," Mr. Youngblood said.

The Mortgage Bankers Association recently asked the Financial Accounting Standards Board for some relief from having to treat all loan modifications as troubled debt restructurings.

After the secondary market seized up last year, many mortgage bankers got caught with mortgages on their books they couldn't sell. The MBA claimed these lenders are not used to holding mortgages and they don't have the computer systems to project discounted cash flows on principal and interest, as required by FAS 114, to calculate loan impairment or losses.

MBA suggested an alternative (FAS 5) that measures impairment based on the amount of principal the lender does not expect to recover. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/

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