Nonprime Defaults Continue Ascent

The default rate of non-agency securitized subprime loans was 12.40 percent in May, rising 0.41 percent from April and surging 5.68 percent from a year earlier, according to a report from Friedman, Billings & Ramsey. The rate, which is the total of 90-day or longer delinquencies, foreclosures, and real estate owned, is at its highest since reaching 13.42 percent in August 1997 — the peak of the prior decade.

For Alt-A mortgages, the default rate came in at 2.69 percent — the highest level Friedman has recorded since January 2000, according to the report. May’s rate was up 0.21 percent from April and 1.80 percent from a year earlier.

Friedman said May represented the 24th consecutive month default rates have risen for securitized subprime and Alt-A loans.

The pace of Alt-A default rates rose slowly from the trough of 0.74 percent in October 2005, but began to rise rapidly — 12 BPS or more – every month since August 2006.

Subprime loan defaults started up slowly from a trough of 5.37 percent in May 2005 through August 2005 but began to rise briskly thereafter through November 2006 — at which time the rate dramatically surged 101 BPS from the previous month to 10.09 percent. Subsequently, the upward pace slowed and has done so significantly in the past six months, Friedman noted.

Nonetheless, analysts of the investment firm still see increased subprime defaults ahead.

“We do not expect any monthly surges in default rates of subprime loans of similar magnitude in the year ahead,” Friedman said. “Rather, we expect default rates to drift upward, to 14.45% in April 2008, assuming that monetary policy does not tighten and labor market conditions do not erode.”

Of 361 metropolitan statistical areas, default rates in 44 areas increased by 200 percent or more year-over-year. These areas consisted of three MSAs in Arizona; all 26 MSAs in California; nine in Florida; two in Nevada; Washington, D.C.; and one MSA in each Idaho, Oregon, and Utah. These areas with the fastest annual default rate changes represent collectively almost two-fifths of subprime loans.

Friedman cited that the “fast year-over-year gains in default rates in these MSAs reflect, with a few exceptions, either the liberal underwriting practices that prevailed among subprime lenders from 3Q05 to 1Q07, especially in coastal areas with a high cost of housing, or the recent weakness in employment in the agricultural areas of California.”

Friedman found it striking that only three of such areas number among 44 MSAs experiencing the highest defaults in May, which altogether represented nearly 13 percent of subprime loans. The other 41 MSAs experiencing the highest monthly defaults consisted of two MSAs in Colorado; six in Indiana; two in Louisiana; 12 in Michigan; three in Minnesota; eleven in Ohio; and one each in Massachusetts, South Carolina, Mississippi, Illinois, and Tennessee.

“We do not expect the default rates of subprime loans in these MSAs to fall significantly until local economic conditions rebound or, in the Gulf Coast, until the public infrastructure damaged by the hurricanes of 2005 is repaired,” Friedman reported. “Similarly, we do not expect the defaults rates of the MSAs experiencing the fastest year-over-year rates of change to converge on those in the Rust Belt unless local economic conditions deteriorate severely, which seems likely only in the agricultural areas of California.”

While subprime and Alt-A performance worsened, the report noted that the default rate of prime loans decreased in May from April — by 5 BPS to 0.37 percent — breaking a streak of nine consecutive increases. The improvement was due to a number of loans that were 90-days or more delinquent being cured or refinanced, avoiding transitioning to foreclosure, Friedman said. Nonetheless, the prime default rate was still 22 BPS higher than in the prior year.