The concern regarding future MTA ARM performance among investors, highlighted by the overwhelming response to the preceding week's Bear Stearns conference call on the matter (see ASR 8/1/05), continued to spill into last week. MTA ARMs currently constitute about 40% of non-agency MBS issuance.
"In many ways this product has become the poster child for all affordability lending by offering the lowest payment mortgage in some of the fastest growing housing markets. It has also become a lightening rod for criticism because of its negative amortization features and the potential for payment shock when the loan is recast," Bear analysts wrote last week.
The timing and extent of negative amortization that could occur with option ARM borrowers depends on a combination of factors - from the mortgage's initial teaser rate, to the payment cap, negative amortization cap and the direction of the MTA index itself, Bear added.
The concern about negative amortization in the product type is not without cause - according to UBS, approximately 75% of MTA loans are currently experiencing negative amortization. UBS wrote in research last week that the high teaser rates attached to 2005 originations will create an even higher portion of loans that are upside-down in this newer class of borrowers. But despite the high portion of negatively amortizing loans, UBS researchers found that it would be quite difficult for an entire deal to experience negative amortization, although it is conceivable should prepayments not offset the payment gap inflicted by defaults and minimum-payment only borrowers.
Negative amortization on a deal would not occur as long as prepayments remain above 2% annually. In that scenario, the impact would hit mostly the IO class, with a negligible effect on the senior classes and a "very low" impact on the subordinated classes, UBS wrote.
But for borrowers currently in an IO product, the MTA loan is the only positive refinancing incentive left, according to Bear analysts. Consequently, the product has attracted a "very large share" of cash-out refinance transactions.
There are three general types of MTA borrowers, Bear added. Nearly half of all MTA loans originated are cash-out refinance transactions - meaning that if home prices rise, borrowers are likely to cash-out again, and conversely, if home prices flatten or decline, prepayments on these loans would likely slow. Some, however, are more sensitive to payments. While MTA ARM borrowers are mostly qualifying at fully-indexed rates, these prospective homeowners would rather just make the minimum payment; 37% are taking out MTA loans to purchase a new home. The final category is simply short-term borrowers using the MTA loan as a bridge to permanent financing or other options.
On the servicing side, Fitch Ratings issued a report last week outlining the risks and challenges involved in servicing the option ARMs. Because of the multiple payment options on the product, servicers may have to install new software or take other measures to ensure both the borrowers and investors have accurate loan balance information, Fitch wrote.
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