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Prepay Speeds Are Increasing but Not As Before

According to TIB Capital Markets in Dallas, prepayments speeds since the beginning of 2009 have increased but still haven't reached levels seen during the last refinance boom during 2003-2004.

Reed Bateman, a trading assistant with the company, said the mortgage-backed securities market continues to be an attractive investment option for a bank's portfolio. He said it is important to be careful with respect to mortgage prepayments and the effect fast payment speeds may have on the yield and duration of an investment.

Mortgage rates are a bit higher than what the market saw in the first few weeks of January, but because they still remain near record lows, Mr. Reed said this is resulting in more homeowners who are considering refinancing.

"Throw in the $75 billion housing plan announced by the Obama administration that's designed to lower some of the hurdles that could keep homeowners from refinancing, and as you can imagine, we have seen prepayments pick up."

He said one reason the company didn't expect prepayments to pick up significantly was substantially lower home values vs. pre-housing crisis levels, resulting in loan-to-value ratios that were too high for the homeowner to refinance.

"You would typically need the balance remaining on your loan to be at a level no higher than 80% of the home's value. Homeowners that are having the most trouble paying their mortgages have seen their home values plummet, leading to LTV ratios much higher that 80%," according to Mr. Reed in a report that was published on the company's website.

"Another reason we didn't previously expect to see a huge refinancing boom is that with the new more conservative lending standards that have resulted from this mess, a downpayment is a must. However, most homeowners that are struggling with mortgage payments do not have the income, savings, or equity available in their home to be able to put the required money down."

According to Mr. Reed, following the new administration's plan to help struggling homeowners, some things have changed. He said borrowers that can afford to pay the going rate for a fixed-rate mortgage today, but couldn't refinance into that lower rate because their LTV ratio is above 80%, can now refinance with the LTV ratio limit increased to 105%.

"Additionally, $75 billion is being allotted towards restructuring the current mortgages of those homeowners who cannot afford their mortgage even at today's lower rates, reducing their required monthly payment to levels that are affordable given their income," he said.

"Incentives have also been put in place to entice those homeowners who benefit from the plan to remain current on their new or restructured loans, along with incentives for loan servicers and originators to find and work with homeowners who could benefit from the plan."

This would seem to explain the increase in prepayments speeds TIB has seen for MBS pools. "However, several obstacles remain that should keep speeds from increasing sharply."

"The plan does increase the LTV ratio required to refinance to less than 105%. However, a significant number of homeowners in trouble have LTV ratios that are much higher than 105%," he wrote.

"Borrowers who were not truthful about income levels, who don't have the needed documentation or have less than a reasonable credit history, would not qualify for the programs."

"Also, the potential number of homeowners looking to utilize the program could cause a severe backup in the process."

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