Non-agency MBS investors should look for bonds with smaller loan sizes in a structure that is levered to severity, said Amherst Securities Group analysts in a report today.

At current price levels, lower priced housing is attractive to both investors and owner occupants. A large scale investor takeout through a government bulk REO sale would stabalize the pricing of lower priced housing and, in turn, lead to lower loss severity.

Amherst analysts explained that loss severity is also affected by the liquidation value or the mark-to-market property value minus foreclosure discount, which has also been trending narrower in lower priced housing.

A GSE/Federal Housing Administration bulk sales program would help to accelerate takeouts for lower priced housing.

According to the report, if such a program takes off, it has the potential to clear a good part of the shadow inventory (homes that are more than 12 months delinquent, in foreclosure, or in REO) at the lower end of the market. Nearly 900,000 borrowers have not made a payment in 12 months, and another 2.3 million are in foreclosure or in REO, according to Amherst figures.

This figure translates into 3.2 million units of shadow inventory.  Of these 3.2 million homes, 2.4 million are less than $200,000. Small agency loans, which are less than $200,000 represent 75% of the agency shadow inventory by loan count, and close to 1/3 of total shadow inventory, agency plus non-agency, explained the report.

"If the program does not take off, growing investor interest will clear the inventory over time, but that will take a good deal longer," analysts said in the report.

On the other hand, Jumbo loans can only look to owner occupier takeouts and with credit conditions tight for Jumbo loans, "it gives higher priced homes more downside/less upside than lower priced homes," Amherst analysts explained.

Historically lower priced housing has been less stable than its counterpart. Over the last decade the lower priced housing sector saw greater price appreciation from 2001 to mid-2006, then deteriorated more from mid-2006 to present, according to figures provided by the report.

"During the bubble years, the availability of easy credit and mortgages designed with affordable monthly payment attracted many first-time home buyers," said analysts in the report. "When the market bubble burst, those borrowers were the first to default due to faulty underwriting and excess leverage. Lower end home values were further damaged through a vicious feedback cycle as communities concentrated with first-time, lower credit borrowers were burdened with foreclosed properties."


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