Last week, I wrote about specified pool trading and how originators need to take advantage of pay-up opportunities by selling their production into the specified pool market. A separate but related subject is the market for pools backed by loans issued under the government programs designed to help underwater borrowers and stimulate the economy. While the general theme (i.e., the search for slower prepayment speeds) is the same, there are some differences in how the products are must be traded.
Loans issued under the HARP program(s) by definition have high LTVs. (The programs specify that borrowers must have LTVs of at least 80% to qualify.) Technically, pools cannot be marketed as being backed by “HARP loans,” since neither Fannie nor Freddie release that information; as a proxy, pools are described as being backed by “100% refi high-LTV loans.”
The market has developed various tiers to trade the higher LTV product, broken out by both LTV and TBA deliverability. Stratifications that are pooled under the standard product designations (i.e., FNCL and FGLMC, which are deliverable into TBA trades) and that trade at varying payups include pools backed by loans with LTVs of 80-90%, 90-95%, 95-100%, and 100-105%. The importance of deliverability stems from the fact that if the payups for the products disappear, the pools can still be sold into TBAs. This limits the risk that changing circumstances will cause investors to be stuck with illiquid and difficult-to-sell securities.
Pools backed by loans with LTVs higher than 105% are not deliverable into TBAs, and thus cannot be placed in pools with FNCL or FGLMC designations. Loans with LTVs between 105-125% must be pooled under separate acronyms and traded as specified pools. Fannie currently only has the FNCQ program for 30-year loans, while Freddie Mac has the FGU program for 15- 20-, and 30-year loans; these are pooled as FGU4, FGU5, and FGU6 pools, respectively.
These securities currently trade at significant payups over TBAs, particularly for higher coupons, because they have exhibited much slower prepayment speeds than generic MBS. Many investors will try to estimate the “carry advantage” of these securities versus TBAs, which can be estimated through the dollar roll market. For example, Fannie 4.5s are currently rolling at around 5/32s per month. (That means that if the current month is trading at 107-00, pools for the following month’s settlement are trading at 106-27.) A roll calculator shows that 5/32s per month works out to be a financing cost of around 0.25% at a 533% PSA, the reported median speed for the coupon. If you run the security at a 0% PSA , the “implied drop” is now 10/32s. That means that very slow speeds are worth 4-5 ticks per month in carry; a point payup is therefore recouped in 7-8 months.
The newest specified pool categories have come from the HARP2 program, which was designed to facilitate the refinancing of loans with LTVs higher than 125%. These loans are pooled under the FNCR designation for Fannie, and FGU9 for (30-year) Golds. These securities are somewhat different that the 105-125% LTV pools. In addition to not being deliverable into TBAs, these pools cannot be used as collateral in REMIC transactions. (This is because loans with such high LTVs are not “eligible assets” for REMIC transactions.) This suggests that the liquidity for these securities will be worse than for the FNCQ/FGU 105-125% elements, especially in a significant selloff where the coupon trades under par.
However, recent trades show that demand for the >125% LTV pools is strong. While the payups are behind those for FNCQ/FGU pools, the levels garnered in auctions for forward settlement were significantly through TBAs, and imply much better loan prices than those being paid by the GSEs’ cash windows. As with the 105-125% LTV securities, investors are paying for the expectation of very slow speeds; however, loans with very high LTVs are exhibiting almost no voluntary prepayments. Investors are apparently willing to accept the reduced liquidity of the securities and still pay through the TBA market for glacial prepayment speeds and the resulting boost in carry.
A final note is that some observers look for some decent production of 15- and 20-year pools with LTVs greater than 125%. This is because the program creates significant pricing incentives for borrowers to shorten the terms of their loans. At this point, only Freddie Mac has a designation for the shorter-maturity loans (FGU 7 and FGU8 for 15- and 20-year loans, respectively), although Fannie Mae will probably follow suit in the next few months.