Mortgage Servicers to Take Center Stage in Shift to Uniform MBS

(Bloomberg) -- Mortgage loan servicers will be thrust into the spotlight as the success of the so-called Uniform MBS set to launch on June 3 is highly dependent on the continued convergence of prepayment speeds seen in Fannie Mae and Freddie Mac securities.

As U.S. homeowners can prepay their mortgages at par without penalty -- making prepayment speeds a crucial component in the pricing of mortgage bonds and rates -- the Federal Housing Finance Agency releases quarterly prepayment monitoring reports as the “consistency of prepayment rates is important to the success of UMBS and to the efficiency and liquidity of the secondary mortgage market,” according to the agency.

So while the aggregate speed differential between the government-sponsored entities is important, investors and regulators will place greater focus on the prepayment behavior exhibited by loan servicers and specific characteristics that, in total, determine overall speeds. "We expect the market to differentiate less between Freddie and Fannie and place more emphasis on servicers, loan size and weighted-average coupon within UMBS," Brean Capital head of fixed income strategy Scott Buchta said in a telephone interview with Bloomberg News.

On its website, the FHFA makes clear it will "identify and align those Enterprise programs, policies, and practices that could materially affect prepayments," so it’s likely the agency will come to look at individual servicers’ speed profiles, much as the U.S. Department of Housing and Urban Development (HUD) does for the Ginnie Mae universe. "The FHFA has already pressured the GSEs to align their templates and underwriting guidelines," Buchta said. This could lead to a similar situation seen in the Ginnie Mae universe, where HUD has punished fast paying servicers.

Freddie Mac, for one, has gotten ahead of any such problem by pro-actively issuing non-deliverable "alignment overflow pools" that consist of loans from a specific servicer whose speeds stand out from the crowd. By keeping fast paying servicers out of the major pools, the GSEs themselves can help keep their speeds aligned.

Better Lucky Than Good

The FHFA picked a fortuitous time to introduce UMBS, as years of easy monetary policy by the central bank -- which included a Fed Funds rate at zero percent from December 2008 until December 2015 -- helped drive mortgage rates to historic lows that, even after the recent rate rally, still has about 90 percent of borrowers with no incentive to refinance. With speeds now mostly driven by turnover and cash-outs, the differential band the agency wishes to see maintained between Fannie Mae and Freddie Mac -- a Constant Prepayment Rate of about 2 to 3 percent -- has been maintained.

While overall refinance activity remains muted compared to a historic basis, "we are seeing a lot of refis driven by cash outs, however there are still a fair number of customers seeing their ARM rate about to reset who are making the decision to lock into a fixed rate now," Eric Schuppenhauer, president of Home Mortgage for Citizens Bank in Providence, Rhode Island said in a telephone interview with Bloomberg News.

It’s in the future, though, where problems can arise, as "even small differences in the collateral profile between the two GSEs pools could result in a substantial difference in prepayment speeds during a prepayment wave," Barclays Capital MBS analysts wrote last week. This will necessitate regulators and investors keep a close eye not only on loan servicers but such factors as loan size, loan-to-value ratios and credit scores, too.

©2019 Bloomberg L.P.