- MBS By introducing an exercise fee paid by borrowers to MBS investors when transferring their existing mortgages to new properties, there is a potential for improving valuations of existing MBS.
- Enabling portability for agency mortgages would facilitate the ability of numerous current borrowers to sell their homes and purchase new properties, thereby boosting liquidity in the housing market.
- The Home Affordable Refinance Program, implemented from 2009 to 2018, serves as a historical precedent for a policy that brought modifications to existing mortgage and MBS initiatives.
Since the start of 2022, there has been a significant increase in mortgage rates. Consequently, there has been a sharp decline in home purchases, leading to a slowdown in the turnover of housing. The conditional prepayment rate (CPR), which indicates the percentage of the mortgage pool that pre-pays investors annually due to home sales, has dropped from approximately 9 to 4. Additionally, national house-price-appreciation rates have experienced a significant decline and are nearing a point where they may turn negative.
A significant portion of the mortgage market is currently priced at a substantial discount compared to the higher prevailing mortgage rates. This situation discourages borrowers from selling their current homes to purchase new ones, creating a phenomenon known as the “lock-in effect.” As a result, borrower mobility is hindered, housing affordability is negatively impacted, and this has contributed to the ongoing decline in the housing market. Additionally, the substantial decrease in prices of mortgage-backed securities (MBS) and the extensions in their durations have also played a significant role in the recent regional banking crisis.
Potential Benefits of Mortgage Portability: Boosting Borrower Mobility and Potentially Increasing MBS Valuation
Enabling mortgage portability could have several benefits, including promoting borrower mobility and potentially improving the valuation of mortgage-backed securities (MBS). If mortgages were portable, borrowers would have the ability to transfer their existing mortgages with lower rates to finance the purchase of new homes. This increased mobility and affordability for borrowers could potentially stimulate housing purchases and related economic activities, thereby revitalizing the housing market. However, one question arises: What would be the impact on MBS investors?
Our modeling indicates that the introduction of the portability option would lead to a bifurcation of the turnover part of the current regular prepayment S-curve, which illustrates how borrowers respond to mortgage rate incentives. Two separate S-curves would emerge in this scenario.
First, the normal “due-on-sale” S-curve, where borrowers pay back the mortgage principal at the time of sale, would likely be lower than the current S-curve for non-portable MBS. This is because some borrowers may choose to pay a portability fee to transfer their existing mortgages when purchasing new properties. However, this reduction in the due-on-sale S-curve is expected to be relatively small since these borrowers, who are already selling their properties for reasons other than buying new ones, have demonstrated a lower sensitivity to significant discounts in mortgage rates.
Second, the “pay-fee-to-port-mortgage” S-curve would likely be higher, as many borrowers who were previously unable to turn over their existing mortgages due to high prevailing mortgage rates could now pay the fee to transfer their low-rate mortgages to their new property purchases. Given the current low turnover rate of around 3 CPR compared to the previous rate of more than 8 CPR, the difference likely represents the number of borrowers who would take advantage of the portability option if it were made available to them.
Mortgage portability has the potential to enhance borrower mobility, affordability, and housing market activity. While there may be some adjustments in the S-curves and potential implications for MBS investors, the introduction of a portability fee paid by borrowers to MBS investors could potentially improve MBS valuations.
By utilizing mortgage-valuation tools and focusing on Fannie 3s mortgage pools as an illustration, we can determine the breakeven-fee threshold that would result in favorable outcomes for current uniform-MBS investors when the underlying mortgages are made portable. Assuming a scenario where borrowers have the option to port their existing 3.85% mortgage rate to a new property while keeping the new loan within the same MBS pool, we can consider a 3% fee for exercising this portability option.
Considering the drop in turnover rate from around 8 CPR to approximately 3 CPR, the following assumptions are made:
Approximately 5% of borrowers each year will transition from their current non-prepayment status to utilizing the portability option. This would yield a 15 basis point (bps) gain for investors in the first year, resulting in a valuation gain of 99 bps.
About one-third of the existing population with a turnover rate of 3 CPR, equivalent to 1% of the total borrowers in the pool, will switch from paying down the mortgage principal due-on-sale to opting for the pay-fee-to-port option. This would lead to a cost of around 10 bps to investors in the first year, resulting in a valuation loss of 53 bps.
Based on this analysis, incorporating a 3% portability-exercise fee would benefit investors in the 3s MBS market, starting with a gain of 5 bps in the first year and a total valuation gain of 46 bps.
To optimize benefits for the current MBS universe, where approximately 99% is trading at a discount, portability-exercise fees could be structured on a receding scale tied to the degree of mortgage discount.
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While conventional U.S.-agency mortgages generally lack portability, examples from countries like the U.K. and Canada demonstrate the availability of this option. Although modifying existing mortgage and MBS contracts poses challenges, precedents such as the Home Affordable Refinance Program (HARP) implemented from 2009 to 2018 offer guidance. HARP successfully refinanced underwater agency mortgages originated before the financial crisis, overcoming various statutory limitations. The program had overwhelmingly positive effects on borrowers, the housing market, and the broader economy. A study estimated that the HARP program reduced the prime-mortgage default rate by 40% between 2009 and 2013.
