- Making agency mortgages portable would allow many existing borrowers to sell homes and buy new properties, and increase housing-market liquidity.
- If borrowers pay investors in mortgage-backed securities (MBS) an exercise fee when moving the existing mortgage to a new property, valuations for existing MBS may be enhanced.
- The 2009-2018 Home Affordable Refinance Program provides a historical example of a policy that modified existing mortgage and MBS programs.
Mortgage rates have risen sharply since the beginning of 2022. As a result, home purchases have plummeted and housing turnover has slowed from a conditional prepayment rate (CPR) of about 9 to 4. (A 9 CPR means 9% of the mortgage pool prepays investors annually due to home sales.) National house-price-appreciation rates have collapsed and are on the verge of turning negative.
House-price appreciation has trended toward negative amid sharp rate increases
Source: Federal Housing Finance Agency
Existing-home sales and mortgage-turnover rates have fallen sharply since early 2022
Source: National Association of Realtors, MSCI Agency Prepayment Model
The majority of the mortgage universe is at a deep discount to much-higher prevailing mortgage rates, which deters borrowers from selling existing homes to buy new ones. This “lock-in effect” prevents borrower mobility, inhibits housing affordability and has driven the current housing-market slump. The sharp drop in MBS prices and duration extensions were also major drivers of the recent regional banking crisis.
Majority of 30-year agency MBS trading at discount
Unpaid principal balance (UPB), weighted average coupon (WAC), prices for the to-be-announced (TBA) market and model-derived CPR for the universe of 30-year agency MBS, as of May 26, 2023.
In addition, our research1 using the recently released Fannie Mae MBS pool-level social index shows the “lock-in” effect has the most severe impact on socially disadvantaged borrowers.
Turnover rates were lowest for pools with highest social scores
Source: Fannie Mae, Freddie Mac, Recursion, MSCI
Making mortgages portable could help borrower mobility and potentially enhance MBS valuation
If mortgages were portable, borrowers would be able to move their existing lower-rate mortgages to finance new home purchases. The increased borrower mobility and affordability could potentially increase housing purchases and related economic activities, helping revive the housing market. While there may be benefits for borrowers, would MBS investors suffer? If a portability-exercise fee is paid by borrowers to the MBS investors, this could enhance MBS valuations.
Compared with the current regular prepayment S-curve (which shows borrowers’ prepayment-rate response to mortgage-rate incentives), the turnover part of the S-curve would bifurcate into two S-curves with the introduction of the portability option, our modeling shows.
- In our model, the normal “due-on-sale” S-curve, where borrowers pay back the par at the time of sale, would be lower than the current non-portable MBS S-curve. That’s because some borrowers may choose to pay the portability fee to move the existing mortgage if they are buying a new property. This would likely be marginally lower, however, as these existing due-on-sale-turnover borrowers have demonstrated that they are not sensitive to large discounts in mortgage rates, partly because many of them are selling the properties for reasons other than buying a new property.
- The “pay-fee-to-port-mortgage” S-curve, where many borrowers who were prevented from turning over their existing mortgages by the high prevailing mortgage rates can now pay the fee to port the existing low-rate mortgage to their new property purchases. This S-curve would likely be high now, as the turnover rate has dropped from more than 8 CPR to current 3 CPR, and the gap likely represents the depth of borrowers ready to take advantage of the portability option if made available to them.
Bifurcated prepayment S-curves with introduction of portability option
Data as of May 26, 2023.
Using Fannie 3s mortgage pools as an example, and applying MSCI’s mortgage-valuation tools, we can solve for the breakeven-fee level so that existing uniform-MBS investors would benefit from the portability of the underlying mortgages. We assume a 3% fee if a borrower exercises the option to port an existing 3.85% mortgage rate to a new property, and that the new loan stays in the same MBS pool.
The economics of a potential portable agency MBS
Valuations assuming constant option-adjusted-spread levels based on MSCI’s MBS models.
Given that the turnover rate has dropped from about 8 CPR to about 3 CPR, we assume:
- About 5% of borrowers annually will switch from current non-prepayment action to take advantage of the portability option. This represents a gain of 15 basis points (bps) to investors in the first year, and a 99-bp valuation gain.
- About one-third of the existing 3-CPR-turnover population, or 1% of the total borrowers in the pool, will switch from paying down the mortgage principal due-on-sale to pay-fee-to-port. This represents about 10 bps in cost to investors in the first year, and a 53-bp valuation loss.
Based on this analysis, adding the 3% portability-exercise fee will benefit these investors in the to-be-announced 3s MBS market, in the first year at 5 bps, and at a total valuation of 46 bps.
Portability-exercise fees can be made in a receding scale as a degree of mortgage discount, to benefit as much as possible the current MBS universe, 99% of which is trading at a discount.
Precedents for making mortgages portable
Conventional U.S.-agency mortgages are generally not portable, although many U.K. and Canadian mortgages offer this option. There are many hurdles to overcome to modify existing mortgage and MBS contracts. However, precedents like the 2009-2018 Home Affordable Refinance Program (HARP) provide guidance. The HARP program refinanced underwater agency mortgages originated before the financial crisis and overcame many statutory limitations. The benefits of the HARP program were overwhelmingly positive for borrowers, the housing market and the broad economy. Our study estimated that the HARP program was able to reduce the prime-mortgage default rate by 40% between 2009-2013.2
1Yihai Yu, László Ábel Somlai, and Péter Nemesi. “MSCI Agency MBS Model Version 2.1: Single-Family Social Index.” MSCI Research Insight, June 7, 2023.
2David Zhang, Yihai Yu, Tony Tang, and Jack Yu. “HARP refinance and payment reduction improve credit performance.” Credit Suisse, July 18, 2012.