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Delinquency Buyouts Now a Major Driver of Prepayment Rates

In its latest U.S. Securitized Products Outlook, analysts at Barclays Capital expect delinquency buyouts to be a major driver of conventional and Ginnie Mae speeds.

They say different approaches to underwriting standards between FHA and Fannie-Freddie should lead to distinctive prepayment dynamics.

"Conventional voluntary prepayments have probably bottomed," writes analyst Derek Chen in the report. "The risk now lies to the upside, although refinancing sensitivity to rates is unlikely to improve until at least the second half of 2010."

According to the outlook, GSE buyouts should significantly steepen the conventional S-curve and boost the speeds of credit-impaired collateral. But the analysts say an extreme, binary buyout scenario is very unlikely.

"For GNMA, continued tightening in underwriting by the FHA should reduce callability and significantly compress the medium-term GNMA/FNMA speed differential for premiums," Mr. Chen explains.

In 2009, there was an epic slowdown in prepayments. Adjusted for the level of mortgage rates, speeds dropped far below historical norms as extremely tight underwriting, the decline in home prices and increased refinancing costs offset nearly 100 basis points of refinancing incentive, said Barclays Capital.

"At these levels, there is little room for prepays to slow further, and the risk now lies to the upside," adds Mr. Chen.

The return of refinance-ability depends partly on house price affordability, the normalization of underwriting and reduction in risk premiums. When that happens, the analysts at Barclays Capital say not only will overall speeds rise, but the dynamics among different products will also change.

For 2010, HPA should remain weak, delinquencies will likely push higher, and banks should experience record levels of loan losses and indemnification to the GSEs. "Against this backdrop, it is difficult to imagine lenders dramatically loosening underwriting standards any time soon," the report says.

Underwriting is expected to remain tight for the first half of the year. After that, the analysts predict there could be a moderate downward drift in credit.

"Origination would continue to concentrate in low LTV loans, as weak housing and high rescission rates by PMI companies would diminish lender appetite for greater-than-80% LTV loans."

As lenders recalibrate their underwriting standards and vie for more volume, Barclays Capital expects a moderate downward migration in FICO starting in the second half of 2010. While voluntary prepays should remain tepid during 2010, delinquency buyouts are likely to surge, the company says, causing significant tiering among different products, vintages and coupons.

For the past two years, the analysts here observe that Fannie Mae has let delinquencies accumulate, leading to a sevenfold increase in the pipeline with a serious delinquency rate over 6% (by balance).

"This trend will almost certainly change in 2010, as the ramp-up of the HAMP program triggers multiple forms of delinquency buyouts," the analysts write.

"Because modifications take much less time to complete than foreclosures, buyouts should first spike and then abate as some of the existing delinquencies are successfully modified."

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