Prepays Drop as Refi Pipeline Narrows

Prepayments seen among securitized mortgage loans slowed in May as mortgage rates ticked upward and overall eligibility for refinance narrowed, according to industry research by Bank of America and Merrill Lynch analysts. Securitized loans are considered in prepayment when they are refinanced or repaid in full. The effect for a securitization is essentially that the mortgage disappears, taking any future profitability with it, even though the loan itself doesn’t vanish. It simply moves into a new securitization. Since prepayments fundamentally mean reduced payouts for bondholders, sweeping refinance programs signal trouble ahead for investors, despite the help provided to struggling homeowners. The good news to bondholders is: prepayments were relatively slow in May. The bad news to underwater borrowers is: refinance programs appear to be dragging. Prepayments on securitized loans with high loan-to-value and low FICO scores remain slow in May, indicating refinance programs have had a shaky start, the BofA/Merrill analysts noted. Overall voluntary prepayments slowed (~ 0.5% conditional repayment rate, or CPR) in May. Voluntary prepayment speeds outside of curtailment — or monthly repayment in excess of the minimum amount due — came in around 2% to 2.5% CPR accross BofA’s four indices. Voluntary CPRs after negative curtailments were 0.5% to 1% CPR less. Taken as a whole, the remittance data suggests subprime borrowers are locked out and cannot refinance due to their credit profile and despite mortgage rates near historic lows, the analysts said. An estimated 37% of the mortgage universe is currently considered “refinancable” by the analysts, compared with 70% in March and April, since mortgage rates rallied over 5% more recently from lows seen early in the year. Even should efforts arise to increase eligibility for the refinance program, the report’s authors conclude the effect might prove minimal. Currently, the administration’s Making Home Affordable refinance program applies to mortgages owned or guaranteed by the government-sponsored agencies and bearing no more than 105% of the present market value of the house. Discussion around possible expansion of this loan-to-value (LTV) limit to as much as 125% began last week. Only an estimated 6% of agency loans bear LTVs between 105% and 125%, however, and analysts said any move by the administration to increase the LTV limits would therefore have no significant impact on prepayment speeds. But then the problem might lie not with the fundamentals of the refi program, but with the originators involved in facilitating refinancings, according to analysts: “A combination of reduction in the mortgage industry workforce coupled with funding shortfalls for non-bank lenders has hampered origination capacity versus the capacity in 2003.” For instance, borrowers considered to be in the highest tier for refinance — FICO greater than 740 and current LTV less than 80% — are prepaying at about 45% CPR compared with 60% in the ’03 refinance wave. The capacity issues hampering originators’ efforts to push refinancings through the pipeline are also affecting modification efforts, the report concluded. “There was no significant pick up in modification activity across various servicers this month,” analysts noted. “We believe that servicers are facing logistical hurdles in transitioning to the new MHA program. Furthermore, it will take some time for the loan modifications under the MHA program to appear in the remittance data because a modification under the MHA becomes permanent only after 3-month trial period.” Write to Diana Golobay. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.