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44 MORNINGSTAR PREDICTS DROP IN PREPAYMENTS Morningstar Credit Ratings issued a statement in January saying that they expect a reduction in mortgage prepayments, which could lead to increased default risk in securitizations of residential mortgage. "We anticipate that mortgages with loan- to-value ratios under 60 percent and interest rates under 6 percent will exhibit the biggest drop in prepayments," said Morningstar analysts Gaurav Singhania and Olgay Cangur. "By our estimate, the concentration of this rate-sensitive borrower is 2.5 times higher in the post-crisis transactions." e analysts expect rising interest rates to cause a disproportionately greater reduction in prepayments for post-crisis originations that have a higher concentration of low interest rate, low LTV mortgage. "Using the CoreLogic, Inc. Home Price Index to determine the LTVs, we expect that approximately $164.77 billion of private-label mortgages, which represents nearly a third of the non-agency universe, are likely to see their prepayments cut in half if the rate refinancing incentives disappear," Singhania and Cangur said. e analysts said the Fed raising its benchmark overnight lending raid to the .50 to .75 percent range from the .25 to .50 percent range will make financing a home more expensive. "In the benign U.S. interest-rate environment of recent years, the rapid pace of prepayments arguably has played a role in containing defaults," they said. "Tighter mortgage underwriting, low LTV requirements, and 100% due diligence in post- crisis jumbo RMBS transactions have limited defaults to only a handful of loans over the past seven years." Rising interest rates, they say, could potentially drastically cut prepayments and increase risk in RMBS transactions. "Much will depend on the regulatory landscape under the Trump administration," they said. Morningstar analysts found prepayments were sensitive to interest rates whether they be agency or private-label RMBS deals, which borrowers with more equity in their homes being more rate sensitive. "We found that borrowers with more equity in their homes prepay more often and respond earlier to a smaller reduction in rates compared with borrowers with less equity in their homes," they said. DISTRESSED SALES ARE STILL ON THE DECLINE Distressed sales dropped by 2.9 percentage points year-over-year since October 2015, according to a report released on January 25 by CoreLogic. Principal Economist Molly Boesel with CoreLogic said distressed sales, of which REO sales made up 5 percent and short sales made up 2.6 percent in October 2016, fell to 7.7 percent that month–the lowest distressed sales share for any month since October 2007. "At its peak in January 2009, distressed sales totaled 32.4 percent of all sales with REO sales representing 27.9 percent of that share," Boesel said. "e precrisis share of distressed sales was traditionally about 2 percent. If the current year-over-year decrease in the distressed sales share continues, it will reach that "normal" 2-percent mark in mid-2018." She said all but eight states recorded lower distressed sales shares in October 2016 compared with a year earlier. Maryland led with the largest share of distressed sales of any state at 18.6 percent, followed by Connecticut at 18.3 percent, Michigan at 17 percent, New Jersey at 15.8 percent, and Illinois at 14.7 percent. "While some states stand out as having high distressed sales shares, only North Dakota and the District of Columbia are close to their pre- crisis levels," Boesel said. Cash sales accounted for 31.8 percent of all home sales in October 2016, down 2.7 percentage points from the previous year. "e cash sales share peaked in January 2011 when cash transactions accounted for 46.6 percent of total home sales nationally," Boesel said. "Prior to the housing crisis, the cash sales share of total home sales averaged approximately 25 percent. If the cash sales share continues to fall at the same rate it did in October 2016, the share should hit 25 percent by mid-2018." REO sales had the largest cash sales share in October 2016 at 59.2 percent, according to CoreLogic data. Resales had the next highest cash sales share at 31.7 percent, followed by short sales at 30.2 percent and newly constructed homes at 15.9 percent. While the percentage of REO sales within the all-cash category remained high, REO transactions have declined since peaking in January 2011.

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