Fannie Prepays Could Grow by 10%, Says BofA Merrill Lynch

The Federal Reserve began winding down its agency mortgage-backed securities (MBS) purchase program, announcing $2bn fewer purchases for the week ending September 30, while a separate Fed program, the Term Asset-Backed Securities Loan Facility (TALF) continues to have a strong impact on the commercial mortgage market and has already pulled spreads lower. Despite the news of the MBS purchase program's extended deadline through March 2010, the market's focus may soon shift to Treasury auctions and the September agency prepayment speeds to be released this week, according to a recent Bank of America (BofA) Merrill Lynch Global Research report. Researchers expect Fannie Mae (FNM) fixed-rate prepays to increase by 10% in September, indicating a broadening reach of mortgage workouts like refinancings that essentially pull loans out of securitizations and into prepayment status, although the loans have technically not disappeared but perhaps moved to another securitization. BofA Merrill Lynch researchers noted the Office of the Comptroller of the Currency (OCC) recently indicated 61% of trial modifications under the Home Affordable Modification Program (HAMP) occurred for Fannie- and Freddie Mac (FRE)-serviced loans. The Federal Housing Finance Agency (FHFA) said in a foreclosure prevention report Friday the agencies so far started 202,200 HAMP trial modifications. Through HAMP, the Treasury Department allots capped incentives to servicers that pursue modifications for borrowers at risk of delinquency. Many of those modifications still await permanent modification status within the three-month trial modification period used to determine borrower ability to repay modified terms. Recent analysis by Amherst Securities Group indicates it may take much longer than three months to determine the ultimate performance of HAMP modifications, as historic 12-month recidivism — or re-default — rates on all modified loans sit at about 70%. Amherst analysis of some 7m loans "destined to liquidate" was not optimistic about the ultimate success of HAMP modifications. "[T]rends in loan modification related prepayments will attract most of the attention in the upcoming report – so expect some volatility in the performance of coupon swaps and Trust IOs next week," BofA Merrill Lynch researchers wrote in the report. The (BofA) Merrill Lynch Global Research report also noted that TALF has helped tighten super-senior spreads in recent months. Researchers indicated in their retrospective report that facility timing bears a significant implication for the levered return that a CMBS TALF investor can expect. TALF aims to keep credit flowing to households and businesses by lending to investors of highly-rated ABS and commercial mortgage-backed securities (CMBS). Historical spreads over the TALF subscription periods for both shorter and longer paper show a noticeable tightening around July 2 when the Fed announced details of the first Legacy TALF subscription including that trades had to take place on or after July 6th. "That said, we think it would be a mistake to ignore the spread and price volatility during the second subscription period, when the dollar price for the longer paper reached as high as $96 before subsequently declining just prior to the subscription cut-off date," BofA Merrill Lynch researchers wrote. Write to Diana Golobay.

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