Compass Analytics 580 California Street, Suite 1725 San Francisco, CA

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1 Compass Analytics 580 California Street, Suite 1725 San Francisco, CA The Month in Review December 2012 What's New? Wishing Everyone a Wonderful Holiday Season and Best Wishes for the New Year! Upcoming Webinars MSR Accounting Webinar Hosted by Compass Analytics and Richey May When: January 8, 2013 at 10:00am PST We are excited to announce an MSR Accounting webinar hosted by Compass Analytics and Richey May. This webinar is particularly useful for new servicers who are seeking guidance with respect to booking the MSR asset, including applicable balance sheet conventions, as well as important tax considerations when servicing. Start out your new year and servicing portfolio with this informative webinar! There is no fee for Webinars or Webcasts and the material is suitable for various levels. Typically Webinars are reserved for current Compass clients, but for more information about registering and Webinar training opportunities please kmccann@compass-analytics.com. Also, ask us about our growing library of Webcasts (recorded trainings) that cover many CompassPoint tools and functionality as well as current business topics such as retaining servicing. Market Update Following a month in which bond prices did suffer some volatility but, ultimately, remained mostly sideways-trending, we find ourselves with a 10-year Treasury yield of about 1.70% and mortgage rates still near historic lows. The economic data remain mixed to some extent, with both improving and declining measures appearing on recent reports. Improvements in consumer confidence appear to be moderating after a rapid improvement over the last few months and industrial production has slipped somewhat from the levels seen this summer. Employment data have been stronger than what was seen over the Spring - and the unemployment rate is now the lowest in a few years - but for all the apparent improvement, job growth numbers remain rather muted. On the Fed front, the latest FOMC meeting adjourned with the release of a new statement methodology regarding forward rate guidance. Over the last several meetings, the Fed has endeavored to be more specific in messaging their expectations for rate changes in the future. This has previously taken the form of a timeline expectation as to when changes were likely to

2 occur. In their previous statement, the Fed reiterated their expectation that the 0.0% -.25% Fed Funds rate would remain in place into Other accommodative measures also had their respective timelines. This was based on their assumption of continued weak growth and contained inflation over the next couple of years. The latest statement saw a change whereby the Fed moved away from a time-based guidance, at least regarding the Fed Funds target, and towards one more specifically data based. The Fed has now presented a few "guideposts" that will help determine changes in the Fed Funds rate and the creation and/or continuation of other accommodative measures. The Fed now states that they expect rates to stay low for as long as the unemployment rate remains above 6.5%, inflation forecasts remain near its 2.0% target, and long-term inflation expectations remain stable. Effectively, this doesn't suggest a change from their previous statement in that they currently expect the unemployment rate to drop to near 6.5% in The Fed was also careful to note that they are allowing plenty of wiggle room in that other factors and future expectations will come into play when making their decisions, even if one or more guideposts have been reached. In essence, it doesn't appear that the Fed has materially changed the way they will view data or make their policy decisions. The same data that the Bernanke Fed has used in their sort- and long-term views of growth and price stability will still be the primary drivers going forward. The recent changes have been directed towards transparency and providing the markets with more clarity as to their intentions in the future. From that perspective, it appears that they have had some success. - Lindsay Hill Specified Pool Commentary The gravy train continued for specified pools in November/December as pay-ups for call protection paper prolonged their record ascent. Low loan balance and HARP pools still reign supreme as investors were willing to pay two point premiums over TBA on 3.5s. Prepayment speeds remained elevated in November but actually slowed modestly as Hurricane Sandy and reduced workdays were seen as the culprits. Going forward, the picture gets a little murky as numerous policy changes, including higher g-fees and reps and warrants adjustments, have yet to fully work their way through the system. Rumors continue to swirl around leadership changes at the FHFA, leaving the outcome and potential impact on speeds difficult to predict. However, speeds could be significantly influenced as the next director may loosen guidelines to allow more borrowers take advantage of record low rates. Amongst the options, the "one time" limitation to refinance under the HARP program may be removed. This would clearly have an impact on HARP speeds that have been remarkably low. Also, principle forgiveness will likely be relevant again after being tabled by current FHFA director, Edward Demarco. Since last month, pay-ups on low balance FN30 3.0% coupon increased across the board once again. However, FN30 3.0% new production (0-1 WALA) pools remain elusive. Larger pools sizes have successfully eked out a ¼ to ½ tick pay-ups. Current coupon 10yr and 20yr pay-ups continue to be anemic and the high balance FNCK pools continue to be punished. Copyright Compass Analytics, LLC Page 2

3 New Production (0-1WALA) 50bps spread between gross and net rate Levels are for indicative purposes only -Jeff Casella Margin Tracker The FN30CC Spread is the difference between the FN30 Note Rate and the FN30 Current Coupon, in basis points. Typically, mortgage rates and noterate-level spreads over current coupon are negatively correlated, and our observations in October and early September provided another good example of this relationship, (FN30Interp ranged from a low of 1.85% to a high of 2.30%), with the spreads widening as rates declined, and tightening when the rates increased. As rates increased throughout October, the peak to trough differential between FN30NR and FN30CC tightened, pushing the average reading lower by 4bps versus last month's levels. The tightest the spread got was 134bps; the widest was 175bps; the average was 147bps. The FN30 NR is the average conventional note rate across a subset of Compass's client base normalized for volume. The FN30 CC is the Fannie 30-year Mortgage Backed Security yield at par 30 days out. The difference between these numbers gives an indication as to how much margin is priced into the secondary market. The primary factors are interest rates, operational capacity and warehouse line constraints. Lenders may also be slower to improve rates during a rally, and quick to drop their pricing during a sell-off. -Bob Gundel Copyright Compass Analytics, LLC Page 3

4 MSR Rich/Cheap & Mandatory/Best Effort Spread MSR Rich Cheap and Profit Margins and BE/Mand Spreads all traded in tight ranges throughout the month. With competition scarce and the bid for servicing from the large aggregators continuing to be soft, the MSR Rich/Cheap averaged 23.66%, a 0.23% decrease from the reading in October. The peak IRR value was 26.5% and the low value was 18.8%. With rates trading in a tight range throughout the month, the Conventional BE/Mandatory Spread remained elevated but displayed some volatility, with an average value of 51 bps, a 2bp increase over the reading in October. The peak value was 60bps and the trough was 44bps. The average 30-year gross profit margin increased significantly again over last month s values with an average reading of 201bps, a peak of 228bps and a trough of 184bps, as Lenders looked to slow down production volume to a manageable level. The MSR Rich/Cheap gives the internal rate of return for retaining servicing and provides a general measure of how aggressive aggregators are in their servicing bid. If a client is considering retaining servicing, or is deciding between retaining or selling servicing-released on any given day, this number can serve as a guide. Compass uses best execution across aggregators each day for note rates bracketing the FN30NR. The Mandatory/BE spread tracks the difference of a representative seller's basis point pick-up using mandatory delivery instead of best efforts. Compass uses several investors, for best efforts and mandatory, and compares the best execution of each of the two delivery methods for note rates flanking the FN30NR. The Conventional 30-year average gross profit margin tracks the originator's gross profit margin, i.e. the difference between what the originator pays for the loan (what is posted on a rate sheet) and what the originator could sell the loan for into the secondary market. - Bob Gundel Copyright Compass Analytics, LLC Page 4

5 Monthly Spreads Mortgage spreads were relatively stable throughout the past six weeks as traders continued to wait for a Fiscal Cliff resolution before placing any major bets. Although US economic data has firmed lately, equities have not rallied much and bonds have remained well bid as the magnitude of the Fiscal Cliff consequences trumps daily economic news. The dramatic tightening of spreads between mortgages and both LIBOR assets and swaps that followed QE3 has corrected a bit. Mortgage yield, measured as a spread over a blend of the 2 and 10 year points on the swap curve, held constant in a narrow basis point range during the period. Given the post-qe3 tights around 40 basis points, and with Fed purchases expected to comprise a higher share of 2013 MBS issuance, there appears to be basis points of room for additional tightening between mortgages and swaps. On a LIBOR-OAS basis, mortgage yield also retraced some of the post-qe3 tightening, widening 7 basis points to close at -6.6 basis points on December 10th. November's benign prepayment report likely contributed to this option-adjusted-spread widening. On December 10th, the 2-10 Treasury spread closed at 138 bps, flattening 6 basis points since the beginning of November. -Dylan Faerstein Copyright Compass Analytics, LLC Page 5

6 Swap Curve Analysis Rates markets traded in a narrow range over the past six weeks as investors waited for some certainty regarding the Fiscal Cliff and the near term direction of yields. After a November 6th spike on rumors of an impending Romney victory, the 10 year swap yield ground lower, closing December 10th at 167 basis points, 10 basis points below its November 1st level. Yields in the belly of the curve also fell, with the 2 year down 3 basis points, the 3 year down 5 basis points and the 5 year down 10 basis points on the period. A portion of the steepening that occurred following the QE3 announcement has been reversed, with both the 1-5 LIBOR/swap and 2-10 swaps spread flattening 7 basis points. The Federal Open Market Committee, with its reassurance that inflation will remain "run at or below its 2 percent objective" has been somewhat successful in easing inflation fears. Technical trading has continued to play a greater role in the range-bound markets, evidenced by yields' reluctance to move. Even worrisome European headlines and November's payrolls number, which nearly doubled investor expectations at 146,000 new jobs, had little impact on levels. The period's largest daily move occurred on November 7th, following Obama's reelection, as traders priced in more years of Obama, Bernanke and accommodative policy; the 5 year swap yield fell 7 basis points and the 10 year fell 11 basis points during that session. -Dylan Faerstein Copyright Compass Analytics, LLC Page 6

7 Production Index Production in the 30-day period ending December 10, 2012 increased while rates traded in a narrower range (7 bp range in this period versus 22 bp in the prior period), with the average yield decreasing month over month by 1 bp. Average volume for the last 30 days was 259% of our base volume (vs. 249% in the prior period) ranging from a low of 94% to a high of 643%. The average yield on the FN30 RNY in this period was 2.801% (vs % in the prior period) ranging from a low of 2.766% to a high of 2.836%. - Bopha Sok Compass Analytics Copyright Compass Analytics, LLC Page 7