HARP 2.0 sentiment already being felt in secondary market
Last month's announced expansion of the Home Affordable Refinance Program, which remains weeks away from actualization, caused investor discomfort because of its expected impact on mortgage-backed securities issued by Fannie Mae and Freddie Mac. While the impact of HARP 2.0 is likely to be felt strongly in the higher coupon space, the entire market is feeling the ripples. Investment bank Bank of America Merrill Lynch (BAC) said October mortgage prepayments ticked up 5 to 10%, for example. Kevin Cavin, a market analyst with Birmingham, Ala.-based securities firm Sterne Agee said spreads on conventional 30-year 5.5s and 6s widened sharply in response to the HARP 2.0 announcement last Monday. "The market recovered over the following three days as investors formed expectations about its impact on speeds and is now widening again as investors reassess the downside risk that HARP 2.0 will indeed have a significant impact on speeds in 1H12," Cavin said in a note to clients. As expected, the market is favoring lower interest rate coupons as the prepayment risk is not nearly as acute. However, the trend is limited to those niche areas on the coupon stack. Cavin added that there continues to be a lot of prepayment uncertainty throughout much of the MBS market, "with prepayment models struggling to appropriately calibrate the impact of a plethora of driving factors including HARP 2.0, delinquency buyouts" and other factors. "We have observed several securities whose performance can withstand a relatively severe prepayment scenario and we’ve seen others in which the downside risk is unpalatable," he said. Under the HARP 2.0, the FHFA will allow refinancing of loans guaranteed by Fannie Mae and Freddie Mac no matter the home's value and extend the term of the HARP through next year and 2013. The HARP changes, which allow more homeowners to refinance, help address responsible borrowers who owe more than what their home is worth. However, analysts say that an added increase in prepayments could alienate the investors who provide the bulk of all credit to homeowners by purchasing the securities packaged by Fannie Mae and Freddie Mac. Investors who value MBS based on the level of refinancing have seen their portfolios move drastically as the government tweaked its rules, leading them to raise the premium they require to accept greater uncertainty. As a loan is refinanced, the principal is returned to the investor at face value, but with high-rate MBS, prepayments cause steep losses. Since 2009, only 894,000 borrowers have used the HARP, of which just 70,000 were significantly underwater. Write to Justin T. Hilley. Follow him on Twitter @JustinHilley.