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With HARP Stalling, MBS Researchers Don't Expect a New Refinance Wave

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Recent record-low mortgage rates are spurring investor fears that a government-sponsored refinance wave could push mortgage prepayment speeds within securitization back to 2003 levels. Despite several options for facilitating a government-driven refinance wave -- and the obvious benefit to homeowners -- "excessive optimism or fear are both misplaced," as such a policy would face significant logistical challenges, according to commentary from the Credit Suisse (CS) fixed-income research team led by senior strategist Mahesh Swaminathan. A government-sponsored refinance program would have to overcome the current market's "numerous bottlenecks" to refinancing, which include debt-to-income, documentation and cash constraints, as well as servicer capacity constraints, Swaminathan's team said. Such barriers have already blocked the Home Affordable Refinance Program (HARP) program from having much success, they noted. According to the Federal Housing Finance Agency's February/March foreclosure prevention and refinance report, Fannie Mae and Freddie Mac refinanced nearly 291,600 loans through HARP as of March 2010 -- out of a target of 4m -- at speeds that remain largely stable: A number of options for a new government-sponsored refinance wave include a national interest rate and a reclassification of refis as modifications, both of which may ultimately raise the cost of borrowing, according to commentary from the JP Morgan Securities (JPM) fixed-income strategy group, led by Matthew Jozoff. "A refi wave is difficult to achieve, but if successful, it could reprice mortgages by several points, as base speeds surge, option costs rise, refi costs decline and spreads widen on supply concerns," Jozoff and his team wrote. "Longer-term mortgage rates could be nudged higher as investors demand wider spreads in compensation for greater refi risk." Although the 2009-2010 refi "wavelet" so far falls short of the 2003 wave, Jozoff's team warned a 2003-style wave could materialize. Prepayments have been less than half the 2003 level, with the one-time exception of a buyout surge: While a government-sponsored refinance wave could aid existing borrowers, Jozoff's team estimates it could push mortgage rates 25-50 basis points higher. A national mortgage rate (say 4%) set by the government as a "nuclear option" would not go over well with the private sector and would be tantamount to the nationalization of the mortgage industry, Jozoff's team said. Although this option may have been discussed more heavily in the worst of the post-bubble recession, market conditions no longer warrant such a drastic measure. Another option to encourage a refinance wave -- the reclassification of refis as mods -- would likely entail a government-sponsored incentive for each modification. Aside from proving to be a costly option, it would create a "deluge of new mortgages" that could push mortgage rates higher for new borrowers, Jozoff and his team noted. Swaminathan's team at Credit Suisse suggested the Federal Reserve's balance sheet could be called in to absorb the surge of new mortgages in such a scenario, but this option is unlikely as it "faces huge opposition from policy makers and would complicate an exit strategy." Write to Diana Golobay. Disclosure: the author holds no relevant investments.

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