A Closer Look At How HARP 2.0 Might Impact MBS

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The markets have seemed to calm down a bit this week, after last week’s fairly volatile price action. The 30-year current coupon spread to interpolated (5-10) Treasuries is about 3 basis points cheap to its 60-day average, although the calculation of the current coupon rate is itself fairly difficult in the current market. The “current coupon” is basically the interpolated coupon rate between the coupons above and below parity, adjusting for delay days and the payment frequency. The problem is the quotation for the “discount” coupon. Since Bloomberg is not quoting prices for FNCL 3s, they essentially extrapolate the price on FNCL 3.5s, which distorts the calculation badly. Other providers that quote markets on FNCL 3s will calculate the current coupon in the more traditional fashion; however, the market for 3s is very illiquid, with a huge bid-ask spread. This also affects the current-coupon calculation and (in my mind) makes it unreliable as a market indicator.

I think a better method in this environment is to look at the spread of selected coupons to Treasuries at median speeds. The current spread on Fannie 3.5s and 4s to Treasuries is +185 and +206, respectively, which is approximately 5 bps wide relative to its averages since the beginning of October. This means that MBSs appear to be fairly cheap, although given the recent spate of volatility I think prices have held
up fairly well.

There has been a lot of commentary out today on the HARP 2.0 announcements by Fannie Mae and Freddie Mac. One interesting element is the quite specific language that must be used on the solicitation of refinancings. (“Solicitation” has always been a charged phrase for mortgage investors; for years, large servicers have been accused of churning their portfolios to generate refi volumes at the expense of investors holding premium coupons.) Fannie’s Selling Guide announcement states that “(L)enders may solicit borrowers with mortgages owned or securitized by a particular government-sponsored enterprise (GSE), provided that the lender simultaneously applies the same advertising
and solicitation activities…to borrowers of mortgage loans…owned or securitized by the other GSE.” Moreover, it states the following:

If lenders choose to reach out to borrowers, and the lender’s communication includes a reference to a GSE, then the communication must include the following:

  • “Freddie Mac and Fannie Mae have adopted changes to the Home Affordable Refinance Program (HARP) and you may be eligible to take advantage of these changes.”
  • “If your loan is owned or guaranteed by either Freddie Mac or Fannie Mae, you may be eligible to refinance your mortgage under the enhanced and expanded provisions of HARP.”

What’s interesting to me is that the policies are trying to prevent lenders from aligning with one or the other GSE to promote its interests at the expense of the other. This has great meaning at current price levels; for example, owners of Gold 6s (currently trading with a 109 handle) want to know that lenders are not targeting Freddie pools while holding back on loans pooled into Fannies. This language is also in addition to the normal prohibitions against solicitation in the seller/servicer guidelines; if memory serves, these allow for solicitation as long as particular securitizer or class of investors is not targeted.

The other important element is the announcement of a set of new pool prefixes for pools containing loans with LTVs above 125%. For 30-year Fannies, new loans with >125% LTVs will be securitized in the new FNCR designation. These pools will not be deliverable into TBAs, which will limit their liquidity; moreover, my understanding is that they also cannot be used as collateral for REMICs. (I’ve read that it’s a tax issue, probably because loans with LTVs above 125% are not considered REMIC-eligible under the 1986 law that created the REMIC designation.) As a result, I expect these FNCR pools to trade very poorly; the price concession will in turn be passed on to borrowers in the form of higher rates. This will offset much of the benefit of the reduction in LLPAs.

Depending on the extent of the concession, security pricing will also impact the impact of the program on premium coupons. For example, a half-point concession (entirely possible for an asset that can’t be included in a REMIC) implies a quarter-point higher rate, all things equal; a full point concession implies roughly a 50 basis point premium. That will raise the threshold of borrower note rates that can materially benefit from refinancing. Given the fact that many loans will also have the maximum of 0.75% in add-ons (both LLPAs and Adverse Market Delivery Charges, or AMDCs), I don’t expect to see significant amounts of HARP refinancing for coupons lower than 5.5s.