No matter which way one tries to rationalize it, subprime mortgages originated in 2006 are piling up delinquencies faster than some of the fiercest housing bears might have imagined. In fact, Moody's Investors Service earlier this month put on watch for downgrade several tranches of a home equity deal closed just six months ago - in May.
The class M-10 and M-11 notes of SG Mortgage Securities Trust 2006-FRE1, rated Ba1' and Ba2', are both at risk of a downgrade. The deal is backed by a mix of subprime first lien adjustable and fixed rate mortgages originated by subprime lender Fremont Home Loans. Societe Generale and Deutsche Bank co-lead the deal; Wells Fargo is the servicer. Standard and Poor's and Fitch Ratings both rated the deal, but neither had issued an official review for downgrade as of press time.
As of Nov. 10, roughly 6% of the securitized mortgage pool was more than 60 days delinquent or in foreclosure, according to Moody's. "Rarely do we see losses in the first six to eight months. That is why we are trying to see if there is a difference here," said Nicolas Weill, managing director and chief credit officer in the rating agency's structured finance group. "Early losses could be a signal of underwriting concerns."
Some worry that heavy CDO purchasing of recently issued subprime mortgage deals - along with the rate at which they are referenced in the secondary market - could lead to trouble down the road, especially if the collateral is performing this bad, this soon. On the other hand, some, such as JPMorgan Securities, have suggested that CDO buying of subprime securities could, in fact, be what ensures a softer landing for troubled borrowers. Without the liquidity provided by the CDO machine, they say, the borrowers would have fewer options when time or circumstance necessitated they refinance their mortgage.
2006 collateral characteristics
"Both 2005 and 2006 vintage loans do not represent the private-label market's shining hour," wrote Gyan Sinha, analyst and senior managing director at Bear Stearns last week. "The pressures resulting from rising rates and compressing margins led many to engage in the equivalent of Hail Mary underwriting, since the only other choice was to suffer a significant reduction in volumes and go out of business due to too high a cost structure,"
Echoing the sentiment of a number of subprime housing advocates, particularly CDO managers, Bear Stearns analysts pointed out that investors need to see the forest through the trees - that is, not all 2006 subprime mortgage deals are going to perform the same across various issuers. In fact, those with a short interest in the 2005 and 2006 vintages could become dismayed waiting several years for the bonds they've referenced to begin accumulating losses.
One thing that is clear is that 2006 vintage subprime mortgages are performing worse than just a year earlier, even with limited documentation and higher collective loan-to-value (CLTV) ratios aside. The average CLTV for the 2006 vintage so far is 88, compared to 86 for the 2005 vintage, but the portion of loans with no down payment at all has risen to 38% so far this year, compared to 31% last year and 21% in 2004. In fact, two out of every five of the popular 2/28 subprime ARM in 2006 was funded with no down payment, according to Bear.
But far and away, the biggest problem for the 2006 vintage appears to be a lack of home price appreciation. Bear Stearns analysts found that the 2006 vintage would be 80% less likely to default if it had enjoyed the same 17.87% mean HPA as the 2005 vintage did. The chance of default for the 2006 vintage, with projected 2006 HPA, was 0.70, according to Bear's analysis. When the 2006 mean HPA (assumed at 6.54%) was applied to the 2005 vintage, the probability for default rose to 0.59 from 0.35.
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