With the success of the Home Affordable Refinance Program for Fannie and Freddie borrowers, there is an expected push on the part of the Obama Administration to offer performing borrowers falling outside the agency's purview a way to lower their mortgage payments – through either a refinance or loan modification, Amherst Securities Group said.

Amherst's latest Mortgage Insight Report focuses on the implications of both Sen. Jeff Merkley's plan for refinancing underwater borrowers and the Treasury proposal for modifying mortgages in private-label securitizations. 

The mechanics of the refinance plans are different in that under the Merkley Plan and other refinancing proposals, the loan is removed from the private label securitization trust (PLS trust), whereas under the Treasury plan, the mortgage loans remain in the PLS trust. Sen. Jeff Merkley, D-Ore., introduced his plan last year, proposing that the government would buy underwater mortgages from banks, reduce the principal for eligible borrowers and refinance the loan into a new Federal Housing Administration-backed mortgage.

"We show that the cost/benefit methodology for both programs are very similar for PLS investors: the benefit from the lower default rate must be weighed against the cost of the forgone coupons on the mortgages that would not have defaulted. We find, under plausible assumptions, both programs are modestly net-present-value (NPV) negative to investors," Amherst analysts noted.

The refinancing analysis is heavily dependent upon the discount rate that is used – the lower the discount rate the greater the value of the forgone coupon and the more negative the program. With the increase in price on PLS securities over the past year, the discount rate is considerably lower than a year ago. 

To test if the Merkley Plan was net present value positive for the PLS trust, the loans were divided into four categories: always current; missed payments in the past that now meet HARP requirements; no missed payments in the past six months; more than one late payment in the past year; and loans that are current for less than six months.

"To summarize—for PLS investors, a universal refinance program would not necessarily be NPV positive at this point in time," Amherst noted.

In regards to the implementation of the proposed Treasury plan, borrowers with loan-to-value ratios greater than 125 would automatically be eligible while those with LTVs in the 100-to-125 range would need to show "hardship," to see a modification.

The Treasury program has much less sensitivity to the discount rate than a universal refinance program, reflecting that since the loan remains in the pool, the discount rate is simply the rate at which the coupon differentials are discounted.

"By contrast, in a universal refinance program, the forgone coupon cost is itself discount rate dependent. In addition, in the Treasury Plan the forgone coupon cost for investors only includes the amount beyond the 5-year Treasury subsidy," the analysts stated.

While many investors like the idea of a universal refinance program, in which loans are removed from the PLS, many dislike the Treasury's modification program, where loans would remain in the pools.

However, the report reveals the universal refinance is no longer as beneficial to investors as it was last year—even though, investors have yet to recognize this.