2007 RMBS Performing Poorly

“Some of the early indications we have indicate … there’s still underwriting weaknesses seen in the 2007 vintage,” Federal Deposit Insurance Corp. Chairman Sheila C. Bair said in a recorded interview with the Wall Street Journal online. “The jury is still out on 2007.”

But FBR Capital Markets sees it more clearly.

A newsletter from the company noted the default rate on 2007 vintage subprime adjustable-rate deals soared to 4.04 percent in August from 2.80 percent during July. Real estate owned was up 131 percent.

“The increase in real estate owned is particularly worrisome,” FBR said. “Measures are failing for many borrowers.”

FBR attributed the delinquency jump in the 2007 vintage to continued poor underwriting. The combined loan-to-values were down only 1.5 percent from 2006, credit scores slipped 3 points and debt ratios rose to 42.13 percent from 41.96 percent. Conversely, full-documentation loans accounted for 57.4 percent of subprime loans, up from 53.9 percent the prior year.

“We find little difference between the salient risk characteristics of subprime loans originated in 2007 and 2006,” FBR said. “Therefore, we cannot conclude that lenders have reversed the liberal underwriting criteria of 2007, limited exceptions to these criteria, and strengthened quality control procedures for newly originated subprime loans.”

But the investment banking firm did point out that Countrywide Financial Corp. didn’t change its subprime guidelines until Aug. 15.

Fixed-rate subprime loans from 2007 also defaulted at a higher pace — rising 36 percent to 2.19 percent on Aug. 31, FBR reported. But REO activity was up just 9 percent for fixed-rate vintages, leaving the investment banking firm less concerned about fixed-rate mortgages.

FDIC’s Bair noted problems have already been identified with hybrid 2006 and 2005 subprime mortgages, which are resetting this year and next year and potentially even during 2009. She said as much as $400 billion is estimated for resets this year and $500 billion next year — though the FDIC projects only about $150 billion has reset so far this year and another $250 billion will reset by next year.

She explained many of the loans were underwritten at the start rate — even though some of the subprime adjustable-rate loan resets were as much as 30 percent higher.

“So most of them, because of the way they were underwritten, they’re not going to be able to make the resets,” Bair said. “Refinancing is not going to be an option for a lot of them because there’s not going to be sufficient home price appreciation, sufficient equity to refinance out.

“Restructuring is going to be their only option.”

But the agency’s chief said she wasn’t sure if foreclosures and resets will continue into 2009.

She also talked about her preference of loan modification over a government bailout.

“It’s very difficult to bail out borrowers without bailing out lenders and investors as well,” Bair went on. “You have a complete erosion of market discipline if you have the government come in in this type of situation.”

Noting that she herself has a 15-year fixed-rate mortgage with less than 50 percent LTV, Bair said compassion should be shown for many borrowers who were misled about their loan terms.

“For owner-occupied homes where people have been making regular payments at the starter rate, to try to restructure those loans into more affordable products” is the best solution, the agency’s chief said.

Sam Garcia worked in mortgage lending for twenty years prior to becoming publisher of MortgageDaily.com.

e-mail: mtgsam@aol.com