Mortgage loans originated to U.S. borrowers this year and in late 2005 - marked by an environment of slowing home price appreciation and desperate mortgage brokers - are not performing as well as those loans originated in 2003 and 2004. In fact, subprime mortgage loans originated in the first quarter of this year were experiencing the level of foreclosures within six to seven months that loans originated in 2004 had at 13 months, Bear Stearns analysts Gyan Sinha and Mary Ann Thomas said last week.

And while foreclosures for the 2005 vintage have also been relatively high, 2006 vintage loans appear to be on a faster track to foreclosure. Whether the deals will experience principal write-downs is difficult to model at such an early stage, but is expected to hinge largely on prepayment speeds, overall default levels and deal structure, they said.

The loans are moving faster into the foreclosure process because servicers are having a more difficult time working with borrowers to keep mortgage payments current, a factor, many say, is attributable to weaker underwriting for those loans originated at the tail-end of the U.S. housing boom. Likewise, early payment defaults - those borrowers which never make their first payment or fall behind shortly after - are on the rise in recent vintages.

First payment defaults rose 40% in the two months leading up to September in Saxon Mortgage Services' $26 billion servicing portfolio. This includes loans from Saxon Capital, along with those from other lenders, David Dill, president of Saxon Mortgage Services, said last month. Mortgage fraud experts estimate that as many as half of all early payment default cases can be attributed to some sort of fraud or misrepresentation, such as fudging a borrower's income. Ninety-day or longer default rates for 2006 adjustable-rate subprime mortgages increased by 34% in September, to 2.01%, according to Michael Youngblood, managing director and head of ABS research at Friedman Billings Ramsey. Meanwhile, 2005 subprime ARM defaults rose 11.2% on the month, to 5.28%.

Impact of high delinquencies

How much of an impact the high delinquencies will have on subprime transactions depends on a combination of prepayment speeds and the ultimate level of default, according to Bear, despite overall increases in credit enhancement for more recent vintages. Credit enhancement levels for triple-B minus tranches issued in late 2005 and 2006 have increased by 100 to 150 basis points compared to 2004 vintage deals, Bear Stearns reported.

Looking at a handful of deals issued in late 2005 and early 2006 experiencing high foreclosure rates before or at 12 months of seasoning, Bear analysts found that - regardless of borrower FICO score - combined LTV, the portion of loans with limited documentation, and the amount of purchase loans within a given pool had the most influence on negative performance.

Using models for prepayment and default, Bear found that a sample of triple-B minus bonds of recent vintages could withstand anywhere from 3.34% cumulative loss to 7.20% cumulative loss before experiencing principal write-downs. For example, the triple-B minus tranche of Residential Asset Securities Corp. 2005-AHL3M9 issued in November 2005 and rated Baa3' and BBB-' by Moody's Investors Service and Standard and Poor's, respectively, has built up 2.66% credit enhancement, and could only withstand 3.34% cumulative loss before the first dollar losses occur. Meanwhile, the Meritage Mortgage Loan Trust 2005-3 M9 issued in the same month, rated Baa3' by Moody's and A-' by S&P, has built up 5.45% credit enhancement and could withstand a 7.20% cumulative loss before it reached its break multiple, according to Bear. The deals were run at a 50% severity.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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