by Calculated Risk on 12/12/2006 09:52:00 AM

Tanta comments on the Fitch’s 2007 Global Structured Finance Outlook

On RMBS:

“More borrowers today than historically are sensitive to a slowdown in HPA due to the increased amount of leverage assumed to afford the higher house prices of recent years. For the entire non-agency sector [prime jumbo plus Alt-A plus subprime], combined LTVs have increased to 83% in 2006 to date from 73% in 2002. The increase in combined LTVs has been driven by a growing number of “combination” first and second liens (also known as “piggyback” second liens), which allow borrowers to purchase homes with little or no downpayment. Also, since 2002, debt-to-income ratios (“DTIs”) are up on average from 37% to 41%. The increase in DTIs is likely understated as the percentage of borrowers choosing “stated-income” documentation programmes has increased to 60% this year from 37% in 2002. Fitch has not seen any strong indications that the trend of increased leverage is abating and the trend will likely continue through 2007.” [emphasis added]

“Under these [Nontraditional Mortgage] guidelines, originators will have to qualify borrowers at a fully indexed, fully amortising rate. Since these guidelines are generally already practiced for prime and Alt-A IO products, the change will likely have the greatest impact on sub-prime IO loan originations and, to a lesser degree, Alt-A option ARM originations. Sub-prime IO borrowers have traditionally been qualified at the IO payment and some Alt-A originators [can anyone say WaMu?] have not used the fully indexed rate to qualify borrowers for option ARMs. Fitch expects the new guidelines to push more subprime borrowers into 40-year loans and to result in a decline in option ARM issuance in the Alt-A sector.”

Tanta: So we have guidance adoption pushing subprime borrowers into 40-year loans. Can anyone out there sketch a pricing model that would make a 40Y FRM affordable to your average overleveraged deeply indebted subprime borrower? Or, alternately, model loss severity expectations on a slowly amortizing 40Y ARM that is a substantial improvement over an IO? I thought not.

Prime Jumbos:

“Credit characteristics of loans originated in 2006 have continued the trend in recent years of weakening risk attributes in the sector. Averages show a trend of increased risk every year since 2003 in almost every major category, with the exception of Fair Isaac Corp (“FICO”) score. The weighted average LTV ratio in 2006 (70.6%) is the highest since 2001. The 2006 DTI ratio (37%), non-owner occupied property (9%) and non-full documentation loans (55%) are all at the highest levels on record. Additionally, more prime borrowers are choosing mortgage products with interest-rate and payment shock risk. Hybrid ARM IO loans now make up the greatest share of new originations. . . . Although still early, there appears to be a marked distinction between fixed-rate and ARM loans when the performance of recent origination is compared with prior vintages at comparable points in their seasoning. Both 15- and 30-year fixed-rate loans originated in 2005 and 2006 are outperforming prior vintages to date when age-adjusted. Conversely, recently originated ARM loans are underperforming prior vintages. The 2006 vintage ARM performance has the highest age-adjusted delinquency of any vintage since 2001.”

Alt-A:

“Credit attributes for Alt-A loans originated in 2006 continue to exhibit the trend towards increased borrower leverage in recent years. While the reported LTV ratios of loans securitised have remained relatively stable, the percentage of loans reporting a subordinate second lien has more than doubled since 2002. Additionally, the weighted average DTI ratio (37%) and the percentage of borrowers using non-full documentation (82%) are both at all-time highs. The high percentage of borrowers with non-full documentation was driven by the growing number of option ARM loans, almost 90% of which chose non-full documentation in 2006. Affordability products dominate the sector, with approximately 75% of the Alt-A loans originated in 2006 falling into that category. . . . The rise in recent vintage delinquency is dramatic relative to earlier vintage option ARM performance, but remains very low in absolute terms and well below the delinquency of other Alt-A products. However, the increase in delinquency does not fully reflect the deterioration in performance of that product. The dramatic increase in short-term rates between 2003 and 2006 has meant much higher interest rates for option ARM borrowers once the teaser period ended. Option ARM borrowers from the 2006 vintage are facing coupons above 7% by month six, several hundred basis points higher than option ARM borrowers from prior vintages at similar points in their seasoning. The result has been a significant increase in the number of borrowers choosing the minimum payment, which negatively amortises the loans. Over 90% of option ARM borrowers from the 2006 vintage are already negatively amortising. However, while the incidence of this is high, the amount of the negative amortisation is relatively small to date. Of those borrowers in this situation, the average rate of negative amortisation is between 1-2% a year. [emphasis added]

Tanta: 90% of Option ARMs originated in 2006 were low or no doc. The rate shock at reset is extreme. Plus 90% of them are negatively amortizing at something like 100% of nominal house price appreciation (at best). But they had a nice-looking FICO when they were originated!

Subprime:

"[T]he loans originated in 2006 have exhibited increased leverage from prior years. While the LTV ratios of the loans securitised has remained relatively stable in recent years, the number of borrowers with reported subordinate second liens has almost doubled since 2004. Additionally, the weighted-average DTI ratio (42%) and the percentage of borrowers choosing non-full documentation (44%) in 2006 are both at all-time highs. [emphasis added]

“The performance of loans originated in 2005 and 2006 generally reflects the increased leverage and delinquencies are up across all product types relative to the age-adjusted delinquency of the 2003 and 2004 vintages. However, the largest challenge of the 2005 and 2006 vintages still lies ahead when roughly three-quarters of those borrowers are required to make a higher monthly payment with the scheduled rate adjustment at month 24. The 2/28 hybrid ARMs originated in 2005 and 2006 have an initial rate below their fully indexed rate and are scheduled to face a rate increase . . . even if Libor remains flat.”

Tanta: A “2/28 hybrid” means the rate is fixed for two years, and then adjusts each 6 months for the remaining 28 years based on the six-month LIBOR. The margin over index could be anything from 300 to 450 basis points. And we are seeing record delinquencies in the first two years, during the fixed period with a discounted start rate.