Market Mover - BNP PARIBAS - Investment Services India

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This section is classified as non-objective researchLiar liarFraud and misrepresentation (the latter, a particularlygrey area) still present an issue and are not likely tobe addressed. Cases where second liens were notreported or were originated after the first lien may notbe relieved from underwriting rep and warrantyclaims. Several loans may have the same borrowerlisted as an owner-occupant, and such cases maynot get rep and warranty relief either. Lenders are notbeing relieved of charter violations; cases with creditenhancement issues on 80+ LTV loans would fallunder that category for example.Can you put it in writing?Other than the general rep and warranty waiverscovering underwriting and automated appraisals thathave always been part of FNM’s HARP guidelines, itappears that explicit language protecting lendersfrom repurchases may not be forthcoming. Duringthe pre-crisis period, underwriting accuracy took abackseat in an effort to meet volumes. However, thatdid not absolve lenders from representation andwarranty risk. As was clear from recent bankearnings, lenders were surprised at the GSEsincreasingly pursuing repurchases of seasonedloans.The recently released report by FHFA criticizedFreddie Mac’s settlement with BoA, particularly thefact that the GSE had not pursued claims onseasoned collateral.http://www.fhfaoig.gov/Content/Files/EVL-2011-006.pdfThe report provides deep insights into FHFA’sperspectives on this issue and text from the reportthat highlights this subject is reviewed below.“The FHFA senior examiner also observed that,despite the apparently changed foreclosure patternsassociated with housing boom era mortgages,Freddie Mac had not adjusted its process foridentifying loans that might be candidates forrepurchase claims. Freddie Mac reviews intensivelyfor repurchase claims only those loans that go intoforeclosure or experience payment problems duringthe first two years following origination”.“Freddie Mac management has advised FHFA-OIGthat they also believe that higher rates of loandefaults in later years do not necessarily equate tohigher defect rates.” [defect = underwriting defect]“…demonstrates the extent to which Freddie Machas not reviewed housing boom era mortgages thatwent into foreclosure during the third through fifthyears after their origination. It shows that by choosingto review intensively only those loans that defaultedwithin two years of origination, Freddie Mac did notexamine close to 100,000 2006 vintage loans.”“Freddie Mac data further show that for allEnterprise-owned foreclosed loans originatedbetween 2004 and 2007, Freddie Mac has notreviewed over 300,000 loans for possible repurchaseclaims. Those loans that were not reviewed(hereafter referred to as “out-of-sample” loans) havea combined unpaid principal balance exceeding $50billion. Many of these loans are likely not candidatesfor repurchase. For instance, a portion of the loansnot reviewed are lower-risk prime loans, whichprobably have a lower incidence of representationand warranty defects. On the other hand, FreddieMac’s portfolio of housing boom loans includes asubstantial number of Interest Only and Alt-Amortgages, which have a high incidence of defects”.Given the risk averse current environment, verbalassurances may not be enough to entice lenders tolend. In Chart 1, we show the overall balance sheetof the banking system. Clearly, banks are heavilyloaded with mortgages and a refi wave would mean aconsiderable loss of NIM. Without an offset such astronger rep and warranty relief, banks would nothave an incentive to increase lending capacity.MI and second liens: nothing new hereIt had initially seemed that new ground had beenbroken on the MI and second lien front, but that maynot be the case. The aim seems to be towardsimproved operational efficiency of MI and second lientransfers to the new loan, but no material newagreements or understandings seem to have takenplace. Large lenders are already part of a second lienre-subordination consortium. Charts 2 and 3demonstrate the considerable presence of MI andsecond liens in higher coupon collateral.LLPA changes do not appear to be a game changereither. Note that the considerable rally in mortgagerates failed to elevate prepays for higher coupons,and thus, it is not clear what increased moneyness atthese low levels of rates would achieve. In fact,prepays on even 5s came in below expectations inSeptember. Chart 4 shows that the effect of including125+ LTVs is expected to be fairly limited. And thispart of the HARP puzzle is not expected to beattacked until next year. 125+ LTV loans would likelytrade as specified pools but different from FNM’sCQs and FRE’s U6 pools which cover 105-125%LTV.Unless details emerge that indicate enhancementsthat are materially better than what appear to be onthe cards right now, we expect do not expect prepayson higher coupons to exceed the 30 CPR area ('086s are currently at 24CPR).Anish Lohokare / Timi Ajibola / Bo Peng 27 October 2011Market Mover34www.GlobalMarkets.bnpparibas.com
This section is classified as non-objective researchPrepays on FN 2008 6s are about 1.5 CPR fasterrelative to FGs at present, after being about 2.5 CPRslower before HARP was introduced. Some of the 4CPR flip is due to higher FN delinquencies whichbecame apparent after buyouts were introduced.Thus, the impact of limited rep and warrant relief isnot outsized.Final details are awaited at this point, and should beavailable on 15 November. Our expectations couldbe revised if final details depart materially fromcurrent indications. Also, efficiency enhancementscould be an ongoing process if the focus onrefinancing is maintained.GNMA DLQ updateIn September prepays, GNII 4s sped up a whooping117%, but the increase in GNI 4s was much moremuted at 28%. GNII 4% speeds (9.1 CPR) thusovertook GNI 4% speeds (6.4 CPR) by a significantmargin. However, the substantial speed increase inGNII 4s was due to buyouts (led primarily by WellsFargo) rather than refinancing. GNII 4% CRRs(voluntary prepays) increased from 1.99 to 2.68 andGNI 4% CRRs from from 2.68 to 4.49. CBRs(buyouts) for GNII 4s increased from 2.14 to 6.30,while for GNI 4s declined from 2.40 to 1.97; WellsGNII 4s CBRs increased from 1.93 to 6.94 and inGNI 4s increased from 3.63 to 4.02. In Chart 5, weshow the voluntary speed increase for 4 through 5sin GNI, GNII and FG. Clearly, once buyouts werestripped out, the call protection afforded by GNs isclear.Overall, the GNMA Delinquency report forSeptember showed a decline in 60-daydelinquencies across all products from 1.36% to1.33%. By Issuer, we saw somewhat similar results.For instance, BofA 60-day delinquencies declinedfrom 1.26% to 1.23%, Chase declined from 1.88% to1.82%, Citi declined from 1.69% to 1.58%, GMACwas flat at 1.73%, Wells declined from 1.08% to1.05% and TBW declined from 4.20% to 3.83%. Inaddition, 30-day delinquencies declined from 3.77%to 3.55%.The overall level of delinquencies continues to be lowwhen compared with the same period over theprevious three years. For instance, versus 1.33% inSeptember 2011, 60-day delinquencies in Septemberduring previous years were 1.54% in 2010, 2.11% in2009 and 1.77% in 2008.Chart 4: 125+ LTV Population by Coupon andVintage – FG 30y Loan LevelCpnVintage2003 2004 2005 2006 2007 2008 2009 2010 20114 2% 1% 1% 6% 11% 5% 0% 0% 0%4.5 1% 2% 2% 8% 17% 4% 0% 0% 0%5 0% 1% 5% 10% 12% 5% 0% 0% 0%5.5 0% 1% 7% 11% 11% 6% 1% 0%6 0% 1% 8% 11% 12% 7% 0%Source: BNP ParibasChart 5: GNMA Voluntary Speeds vs FGsCpnGNI GNII FRESep-11 Aug-11 % Change Sep-11 Aug-11 % Change Sep-11 Aug-11 % Change4 4.49 2.67 68% 2.68 1.99 35% 16.89 7.2 135%4.5 10.23 6.25 64% 7.52 4.17 80% 23.66 12.50 89%5 12.79 9.36 37% 12.01 8.35 44% 21.14 17.32 22%Source: BNP ParibasOverall GNMA 90+ day delinquencies increased from1.46% to 1.54%, and CBRs increased from 3.87 to3.97. The increase in 90+ day delinquencies was,once again, led by BofA whose 90+ daydelinquencies increased from 2.02% to 2.38%, andCBRs declined from 0.74 to 0.51 in September. Aswe mentioned last month, with BofA's 90+ daydelinquency level significantly below GNMA’s 5%threshold it might be focusing on using resourceselsewhere as opposed to delinquent loan buyouts.This delinquency reports seems to confirm thisassumption.FRE MVS – Negative convexity declines in therallyFRE’s retained portfolio was down USD 1.4bn toUSD 679.13bn in September and continues to bewell below the year-end cap of USD 729bn. AgencyMBS declined by USD 2.1bn, non-agency MBSdeclined by USD 1.2bn and whole loans increasedby USD 1.9bn. Total debt outstanding declined byUSD 3.1bn to USD 689.92bn, and delinquenciesincreased by 2bp to 3.51%. The duration gap was 0.The sensitivity of the portfolio to a 50 bp shift in thelevel of rates, a measure of negative convexity,declined substantially from USD 335 mn to USD 152mn. This makes sense given that the portfolio iscomposed primarily of higher coupons which arealready beyond their point of maximum negativeconvexity. A rally only causes higher coupons tomove further away from that point and become lessnegatively convex.Anish Lohokare / Timi Ajibola / Bo Peng 27 October 2011Market Mover35www.GlobalMarkets.bnpparibas.com
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