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Higher Appreciation Sparks Change in Prepay Model

Bear Stearns & Co. recently made temporary modifications to its prepayment projections based on structural changes in the mortgage industry that the company said have helped spur home price appreciation.

In a recent Mortgage Products Special Report titled "New Mortgage Pricing Models," Bear Stearns provided two updates to its fixed-rate prepayment models.

"Recent housing and prepayment data have underscored the importance of home price appreciation as a key driver of prepayment behavior," the report said. "Our current valuation framework assumes that home prices over long periods of time outperform inflation by 50 to 75 bps consistent with historical home price data."

The Bear Stearns report noted that recent home price data have been inconsistent with this long-term historical guideline.

"While we remain comfortable with our long-term assumption, we believe that in the near term home prices are likely to maintain a high level of appreciation driven by recent structural changes in the mortgage industry (e.g., including broader access to credit provided by new affordability mortgage products)," the analysts said.

In view of this outlook, the company said it would bring short-term prepayment projections more in line with expected discount speeds by temporarily modifying the model's assumptions.

Bear Stearns said it plans "to calibrate our short-term home price assumption to the most recent OFHEO year-over-year national home price change and then revert to our long-run assumption of 3.5% over a 36-month period."

In another recent Bear Stearns publication, the June 28 issue of Across the Curve, analyst V.S. Srinivasan put the spotlight on relocation mortgages as a source of protection against a cooling housing market.

"MBS backed by relocation mortgages (relos) have long been one of the most reliable sources of extension protection in the mortgage market," the analyst said. Such mortgages, often securitized as part of collateralized mortgage obligations, are originated under programs maintained by employers who often relocate employees.

"Such transferred employees have a higher likelihood of moving again than the general population of homeowners," the Bear Stearns analyst noted.

Historically, relos prepay much faster than non-relo collateral, and relo discount speeds tend to be less interest-rate-sensitive than the speeds of generic collateral, according to the analyst.

"Traditional borrowers have some ability to postpone a move for affordability reasons if prevailing mortgage rates are significantly higher than their current mortgage," the analyst said. "In contrast, relocation borrowers are much more willing to give up their below-market rate to move."

In other prepayment-related news, Standard & Poor's Ratings Services announced a clarification of its criteria for the inclusion of prepayment penalty income in net-interest-margin security transactions.

S&P said it applies adjustment factors to address the risk of variability in actual collections of prepayment penalties due to such events as default, deviation in voluntary prepayment speeds, and changes in law.

If the transaction's terms allow the servicer or master servicer to waive prepayment penalties for any reason other than those set forth in the standard representations, S&P said it requires that one of two conditions be met.

The first is that an entity rated at least as high as the deal's highest-rate NIM security guarantee the payment of the waived prepayment penalty income to the issuer.

The second condition is that the servicer or master servicer waive a prepayment penalty only if the waived amount is deposited by the servicer in the collection account at the time of payoff.

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