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Prepayment protection in conventional HFA pools
admin | January 25, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Over the last five years, a rising flow of loans has come into the agency MBS market from Housing Finance Authorities, or HFAs. Many states have HFAs to support homeownership among people with lower incomes, and most HFA loans show cash flows that can be more stable than even low loan-balance pools. Since a third of HFA loans last year flowed into generic agency pools backed by multiple issuers, the specified pool market and its investors may have an opportunity to capture part of that flow.
Identifying conventional HFA loans
The typical HFA program offers borrowers a second lien of up to 5% that can be used towards down payment and closing costs. The lien typically requires no payments and is forgiven after a few years, unless the borrower leaves their home.
Most HFA loans are easy to identify—the state HFA is the reported servicer and services their own loans. However, the Alabama and Idaho HFAs have built larger servicing operations and service loans for other states. For example, the Alabama HFA services loans for the Missouri, Mississippi, North Carolina, and Washington HFAs.
Other states use private lenders, and there is no way to directly identify these loans. However it is possible to look for pools backed entirely by loans that fit the typical HFA profile—100% purchase, 100% owner-occupied, and have a second lien of up to 5%. This search identifies many pools issued by U.S. Bank, which runs a division dedicated to originating and servicing loans for state HFAs.
More conventional HFA loans appear to be sold to Fannie Mae than Freddie Mac.
HFA loans prepay slowly, but not all are created equal
Many HFA loans exhibit extremely flat S-curves. Exhibit 1 (below) compares HFA loans to conventional LLB pools—ones containing no loans larger than $85,000.
Exhibit 1: Many HFA loans prepay slower than LLB
Source: Fannie Mae, eMBS, Amherst Pierpont Securities
In general the HFA loans have a flatter and slower S-curve than LLB loans, even though the HFA loans can be much larger; the average original HFA loan size is roughly $150,000 and the largest loans can approach $400,000. They offer substantial prepayment protection in a rally, but will prepay slower in a high rate environment. The second lien discourages the borrower from moving since the borrower would need to repay it. Most borrowers will choose to wait until after the lien is forgiven, but, after forgiveness, show more willingness to move. This is evident in the chart, which shows a smaller gap between HFA and LLB speeds for the 2015 and 2016 loans than for the newer 2017 and 2017 vintage loans.
Three state HFAs, however, have prepaid much faster than others—Colorado, Massachusetts, and Utah. Colorado has been particularly fast for the two older vintages shown, and its S-curve is starting to steepen for the newer vintages. The Amherst Pierpont servicer ranking report shows that Colorado HFA loans prepay 13.5% faster than comparable loans from other servicers and should be avoided.
Supply is increasing
Production of conventional HFA loans has increased over the last five years to roughly 30,000 loans issued in Fannie Mae pools in 2018. This is almost double the 15,000 loans issued in 2014. Roughly 33% of the HFA loans originated in 2018 were place in multi-issuer pools, suggesting that it is possible to create more HFA spec pools. U.S. Bank’s HFA issuance jumped in 2018 to roughly 5,000 loans from less than 1,000 loans in preceding years, reflecting increasing demand for this collateral.
Conclusion
State housing finance authority loans exhibit very flat S-curves, due to the nature of the borrower and the presence of a forgivable second lien that discourages prepayment. The S-curves are very flat and compare favorably to LLB loans in a rally; however, they will underperfom LLB in a sell-off. Production of these loans has been increasing for a number of years and roughly 33% of those loans are being delivered into multi-servicer pools, suggesting that originators could make additional HFA pools if demand warrants.
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