Industry observers have been bracing for October, when an estimated $50 billion worth of adjustable rate mortgages are going to reset to higher rates.

An already beat up market is no doubt jittery about the prospect of a new influx of defaults and delinquencies unraveling from the resets. Some analysts, however, are holding out hope that the Federal Reserve's decision to cut interest rates by 50 basis points last month could soften the blow.

With a number of ARMs backed by one-year Treasurys that follow the fed funds rate, they could be more affordable after the resets than previously forecast. The more affordable rates could translate into fewer delinquencies than had initially been feared.

But not everyone is buying this logic. "The question is how much of a quantitative impact it will have," said Michael Bykhovsky, CEO of Applied Financial Technology (AFT). "It will have some but I don't think it's going to be dramatic. I can't see the meltdown being averted without there being more significant cuts." He added that the Fed's rate cut might somewhat lower longer-term rates and decrease the costs of prime borrowing. This could subsequently make home ownership more affordable.

"Now if you were to ask me whether the 50 basis points is enough to stop the blood bath, the answer is no," Bykhovsky said. "Without it, things would be worse, but only somewhat." According to AFT's data, it would take a cut of about 150 basis points to see a modest impact on the resets. Bykhovsky believes the Fed will eventually tack on an extra 100 basis points to its initial cut.

John Sim, an analyst at JPMorgan Securities, is also skeptical about the degree to which the Fed's rate cut will impact the reset changes. "In principle, it is supposed to help, but I think we'll see rates suspended at 75 CPR," he said. "If it went down to 70 or even 65 CPR, I can see that. But I think ultimately it doesn't make much of a change."

Sim also believes a lot of lenders are still soliciting ARM borrowers, despite the controversy surrounding these types of loans. "The big banks probably no longer do it, but for people who only originate these loans, I think they are still sending out fliers and making calls," he said. "They may not be selling a lot of these loans, but they still have to create them because that's all they do."

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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