With affordability mortgages on the rise, there has been an increased focus on the MTA option ARM product, particularly because of the perceived danger of these borrowers not being able to cope with the potential intense payment shock they may experience upon recast as well as the increasingly negative amortization lenders have reported. However, analysts said that the risk in these products is exaggerated in light of the quality of MTA ARM borrowers.
At a Bear Stearns conference call last week, analysts acknowledged the severe payment shock that MTA ARM borrowers could experience particularly because these loans are "highly teased, " said Bear Senior Managing Director Dale Westhoff.
For the MTA loan, Bear analysts assume a 1.50% initial teaser rate for the first one to three months. The low teaser rate aside, interest accrues monthly based on the MTA index plus a typical 250 basis point additional spread. This, added Westhoff, creates a strong potential for negative amortization if borrowers make only the minimum allowable payment, noting that there is a negative amortization ceiling ranging from 10% to 25% of the loan balance.
But despite the potential payment shock, analysts noted that it is important to note the quality of the borrowers that move in to the MTA product, as well as the refinance alternatives open to them, affording them considerable savings, factors that mitigate the risk.
"The MTA is the only product that gives the borrower the universal incentive to refinance," said Westhoff, pointing to the changing refinancing alternatives now offered to borrowers that have evolved from simply refinancing out of a 30-year mortgage. In the presentation, Bear analysts said that the MTA teaser rates provide an attractive incentive to refinance and that refinancing saves the borrower 375 basis points of interest for three months, providing savings that offset refinancing costs.
Senior Managing Director Gyan Sinha said that investors should not focus on the payment shock but at the type of borrowers that take out this type of loan. He noted that there is anecdotal evidence suggesting that lenders are qualifying borrowers not on the teaser rates but at the fully indexed rate. Sinha added that the payment shock on these loans is not significantly worse than what one would see on a 5/1 hybrid ARM.
The borrowers that move into this product, who typically have 19 to 20 debt-to-income ratios, usually have short horizons and are attracted to the flexibility afforded by the loan. For instance, although most borrowers make a minimum payment, they can choose to amortize based on a 30-year, 15-year or interest only schedule.
Analysts on the call also noted that even though the negative amortization ceiling is hit every five years or is recast fully to the fully amortizing payment, since the horizons of these borrowers are fairly short, the number of borrowers hit by this shock after five years would probably be very small.
Sinha said that the positive technicals have created relative value in the sector. Factors such as robust housing markets, low mortgage rates and a flatter yield curve have caused heavy issuance in the short-reset sector, specifically the non-agency MTA ARM issuance was considerably higher in the second quarter. The oversupply in MTA-indexed option ARMs has been felt most in the triple-A sector, Sinha pointed out, which make up close to 90% of the capital structure. Additionally, this negative supply technical has caused triple-A spreads to widen in recent weeks.
A combination of generally solid underlying fundamentals, including low default rates, low implied volatility and the aforementioned heavy supply has created some relative value opportunities for senior investors, Sinha pointed out. He stated that the relative value opportunities offered by MTA ARMs for triple-A investors range from par and premium floaters to senior basis IOs, offering a pickup in nominal spreads and OAS relative to sectors like supbrime home-equity ABS.
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