Increased Defaults as Interest-Only Loans Recast -Fitch

The ghosts of originations past couldrnstill come back to haunt the housing industry according to a new report fromrnFitch Ratings.  The company says that halfrnof those borrowers who have loans in performing residential mortgage backed securitiesrn(RMBS) are facing increases in their mortgage payments over the next fivernyears.</p

Fitch says the mortgages that willrnbe affected by increases are those with adjustable interest rates (ARMs), loansrnthat have had interest only payment features (IOs), and loans that werernmodified to save or redeem them from default. rnFitch notes that payment increases have historically led to high ratesrnof default with a correlation between the size of the payment increase and therndefault rate.   </p

‘Interest-only loans are in storernfor the largest payment increases,’ said Director Sean Nelson. ‘As a wave ofrnpeak vintage 10-year IOs approaches recast, many mortgage borrowers could seerntheir monthly payments more than double.'</p

ARM payment increases are typicallyrntied to short-term interest rates so the magnitude of those increases arernexpected to be smaller than for IO loans as long as rates continue at therncurrent pattern.  Modified loansrntypically have scheduled and limited rate increases so borrowers should sufferrnless payment shock.  </p

Fitch says the prime jumbo sectorrnhas the most exposure to future payment increases due to a larger compositionrnof ARM and IO loans. Nearly two-thirds of performing prime jumbo loans are atrnrisk, whereas less than half of subprime loans are exposed to future paymentrnhikes. </p

Any payment increases are expectedrnto have little impact on its ratings Fitch says.  Its US RMBS Loan Loss Model projects paymentrnincreases and adjusts the probability of default accordingly. ‘While defaultrnrates are expected to increase for loans with an upcoming payment hike, thernelevated default risk is already baked into our RMBS ratings,’ said Nelson.

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