The recent headlines on residential mortgage credit performance have remained gloomy. The quarterly delinquency survey published by the Mortgage Bankers Association (MBA) painted a pretty desolate picture of mortgage credit performance in the first quarter of 2009, and data from outfits such as RealTrac show continued increases in foreclosures, particularly in the Foreclosures Started category.

However, a closer look at recent data gives a somewhat different picture. Rising foreclosure rates probably represent both the elongated nature of the foreclosure process and the impact of the various moratoria that expired over the last few months, creating a pig-in-a-python effect. Moreover, other data suggest that mortgage performance appears to be bottoming out, led by the subprime sector, even though home prices remain soft.

While it surveys a very large and diverse population, the major problem with the MBA's report is its lack of timeliness. The report published in late May contains data for the first quarter of 2009, making it impossible to gauge current performance. As an alternative, the delinquency and default data reported by Bloomberg give a more contemporaneous view of performance trends. These reports are based on collateral performance provided to Bloomberg's non-agency database by servicers as part of their monthly reporting, broken out into prime, Alt-A and subprime cohorts. (Its major weakness is that it includes only loans securitized in non-agency deals, making it a smaller sample than the MBA's population.)

The Bloomberg data indicate that the number of loans classified as newly delinquent (i.e., 30- and 60-day delinquencies) has leveled off and, in a number of cases, is actually declining. The 30-day delinquencies declined in April for both prime and Alt-A loans, while the percentage of loans that were 60 days delinquent declined for Alt-A products and was unchanged for prime. In addition, both 30- and 60-day subprime delinquencies declined for the third straight month. (It's important to look at both measures; rising 60-day delinquencies could indicate that many of the prior month's 30-day delinquencies remain past due.) These declines in new delinquencies occurred in spite of severe weakness in the labor markets, reflected by an average monthly decline of 656,000 in non-farm payrolls since November of last year.

The improving new delinquency figures for subprime products, as well as stabilizing delinquency numbers for prime and Alt-A products, suggests an interesting and potentially important development. It has long been believed that the credit attributes of RMBS deteriorate over time through "adverse selection"; as borrowers with stronger credit prepay their loans, the pools increasingly consist of loans to weaker borrowers. Over the last year or so, however, voluntary prepayment speeds have been quite low for "credit-challenged" loans, suppressed by both the lack of homeowner equity and the collapse of lending to weaker borrowers. At the same time, the high default rates experienced over the last few years have removed many lower-quality loans from the population. As a result, the subprime deal population continues to factor down, despite the slow rate of voluntary speeds; as an example, the 20 deals backing the ABX 07-2 deal (all originated in the first half of 2007) have an average factor of roughly 0.70.

Taken together, these factors suggest that the subprime population may now be benefiting from a form of "positive selection" that has occurred as weaker borrowers are removed from the pools through foreclosure. This phenomenon may be primarily responsible for the modest but noticeable improvement in the subprime population's performance. Aside from the durability of this trend in a weak labor market, a key question will be whether and how quickly this improvement carries over into the Alt-A and prime loan populations.

Bill Berliner is a mortgage and capital markets consultant based in Southern California. His Web site is www.berlinerconsulting.net

(c) 2009 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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