Retention Emphasis May Spur Refis

In the last quarter of 2007, mortgage servicers dodged a bullet. Despite lower interest rates, prepayment speeds largely lagged analytical models used to project speeds. Most analysts believe that declining home values and tighter underwriting standards limited the volume of refinancing. That yielded "hedging outperformance" for some lenders, meaning their hedge instruments gained in value more than their servicing rights declined in value.

But not every miscalculation by the models will be a good one. It is too early to know how hedging performance held up in the first quarter of 2008, but clearly market conditions suggest that refinancing - and portfolio churning - may be on the rise again.

As lenders tightened underwriting on new loans and eliminated risky loan products, that limited refinancing options for some borrowers. But now, with the mortgage industry under pressure to help out troubled borrowers, refinancing people out of risky, adjustable-rate products into fixed-rate loans seems likely to be part of the solution. That could tip the balance in the other direction, yielding more portfolio turnover than might have been anticipated.

Already, low interest rates have spurred a considerable increase in refinancing and a shift in the loan mix toward fixed-rate products. In early March, refinancing activity exceeded half of all loan applications, according to the weekly loan application survey compiled by the Mortgage Bankers Association. And the average contract rate on mortgage applications dipped to 5.98% for 30-year, fixed-rate loans.

It's unclear whether or not rates will be lower at the end of the first quarter than they were at the beginning. After the average 30-year rate dipped below 6% for five weeks starting in early January, it climbed back up above 6% in mid-February, according to Freddie Mac's weekly survey. In his weekly commentary, Freddie Mac chief economist Frank Nothaft noted that rates trended up for three weeks in a row during February, a factor which may help taper off the nascent refinancing boom that seemed to be building in January.

When this edition of MSN went to press, the Fed's March policy making meeting had not yet taken place, and the future of interest rate movements remained uncertain.

But clearly lenders are in a position where managing interest-rate risk could get tricky. New policies designed to emphasize home retention, coupled with a favorable rate environment, could lead to more refinancing activity than most experts had expected in 2008. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/