For all the dread the collapse of the subprime market has brought to the economy, those looking for a bit of good news have projected a stronger mortgage market on the assumption that lenders have begun tightening their underwriting standards.

Or have they?

Not all industry observers are convinced the fallout from the credit dislocation has resulted in a wave of better loans. They point to the continued increase in default rates of newer vintage adjustable-rate mortgages, even as the market moves into the final three months of the year. The default rate of securitized subprime ARMs originated in 2007 was 8.05%

as of August, according to Michael Youngblood, an analyst at FBR Investment Management, a subsidiary of FBR Capital Markets. By comparison, the default rate of vintage 2006 subprime ARMs was 5.26% at the same age, and the default rate of subprime ARMs originated from 1996 through 2005 was 3.08% at the same age.

"This is an ominous sign," Youngblood said. "Either they have not been sufficiently or rigorously implementing these new standards, or the revised underwriting criteria has not yet taken hold."

A market that grew on the back of no-doc lending and no down payments could have a tough time convincing some critics that it has changed. "The industry's evolution is no mystery," Youngblood said. "The current data has not proven reliable at regaining my confidence. The burden of proof on this industry is tremendous."

Mark Adelson, an independent consultant from Adelson & Jacob Consulting, also notes the increasing delinquency rates of each newer vintage, going back to last year. The delinquency rates increased in the fourth quarter of 2006 over those in the third quarter, and increased again in the first quarter of this year. "That's a chilling result," he said at the Information Management Network's third annual Subprime ABS conference held in Las Vegas last month. "There was a lot of noise about improving underwriting at the tail end of 2006, but it just looks like it didn't happen. I'll believe it when I see it."

Some wonder, though, whether the troubling data on defaults and delinquencies are mostly still a ripple from the meltdown and not a sign that the loose underwriting practice is ongoing. Speaking at the same IMN ABS conference, Jonathon Weiner, a senior analyst for Applied Financial Technology, argued that originators are tightening their standards. "I think when all is said and done, we'll see the worst [for defaults] at the first quarter of 2007 or the fourth quarter of 2006," he said. To be sure, the September remittance reports showed that while the rate of delinquencies continues to increase, it is doing so at a slower rate than it did

in August.

When embattled Countrywide Financial, the nation's top mortgage lender, tapped an $11.5 billion line of credit in August to maintain liquidity, it announced that it would also be tightening its lending standards. In a statement, the company said that it expects 90% of the loans it originates would be GSE-eligible or will meet the investment criteria of Countrywide Bank.

But Youngblood wonders why it took Countrywide so long to make a major correction to its underwriting standards when its troubles had been ongoing. "Countrywide has revised its guidelines several times in 2007, but the most extensive revision occurred on Aug. 15," he said. "Since many mortgage banking companies will follow CFC's lead, the slow pace of revision likely slowed the adoption of tighter underwriting standards generally."

While news that many banks have announced tightened credit standards is encouraging, Youngblood noted that the majority of subprime loans are made by nonbank entities. He argues that in the past, managers with some subprime lenders have exercised their latitude to bypass tightened standards. In other words, tightening guidelines sounds great, but enforcing them is another thing. "Lenders need to limit the ability to make exceptions to the guidelines," he said. "It is not clear that lenders are limiting the authority to make exceptions."

John Sim, an analyst for JPMorgan Securities, says that tighter underwriting guidelines are reflected in higher rates for new or refinanced loans. "Fewer are going to get through than three months ago," he said. Originators will work with their subprime borrowers to refinance their loans even if the borrowers have been defaulting on payments, but the originators will ultimately charge higher rates. "Someone with a subprime product will be paying about 300 basis points higher than they were three months ago," Sim said.

Tom Hendrickson, a broker at Associated Mortgage Group in Portland, Ore., also said he has seen more conservative underwriting guidelines. "They're definitely being enforced by the lenders," he said. "If someone revised guidelines and didn't use them, they will be kind of suspect people anyway."

With fallout from the mortgage meltdown continuing, lenders may need time to convince a lot of industry observers that their standards have improved. Youngblood said that changes in delinquency rates won't reflect improvements in underwriting guidelines until the third quarter of next year.

For others, persuading the skeptics could take longer. "Fool me once, shame on you," Adelson said. "Fool me twice, shame on me."

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

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