Prepayment researchers at Banc One Capital Markets recently released a study on behavior characteristics of $500,000-plus balance, non-prime hybrid adjustable-rate mortgages, finding that, "counterintuitive to traditional wisdom," these high balance cohorts have a similar prepayment profile to the smaller, $200,000 to $300,000 conforming balance ARM pools.

Generally, in prime mortgages, larger loan balances tend to be more prepayment sensitive, because the borrower savings are greater. On the non-prime side, loans follow this pattern until they reach the $500,000 area threshold, at which point the trend reverses, Banc One found.

"The first thing we looked at was prepayment penalties on those large balances," said report author Glenn Shultz, a director in the research group focusing on prepayment modeling and analytics. "What we've found is that the use of prepayment penalties is about the same across all the cohorts, so that doesn't explain the slowdown in prepayments."

After talking to issuers, Banc One theorizes that non-prime borrowers in the $500,000 and up range do not have the same access to capital as their lower balance brethren, because there are fewer originators writing non-prime loans in that range. Further, the credit curing effect, which happens when a borrower in good standing moves into a better loan, takes longer with the larger balances.

The high balance ARMs tend to populate the senior/subordinate portion of the "agency carve-out deals," where Fannie Mae and Freddie Mac wrap the top portions, which are backed by conforming balance pools. The agencies will generally buy the wrapped classes themselves. Option One and Long Beach Mortgage frequently use this structure. The high balance borrowers tend to be at the high end of the non-prime spectrum, in the 600-plus FICO range.

Option One's current deal, which priced last Thursday, was structured as a two-group transaction, instead of having the standard agency wrap on the conforming pool. Interestingly, on the class As, the non-conforming balance group priced at 27 over one-month Libor, two points outside the conforming pool. The sub bonds on that deal are for the benefit of both A classes.

"You're getting an extra two basis points of yield pick-up on a floater because it's a non-conforming balance, when in fact, what we've just shown is that it's not really an issue," Shultz said. "I think that makes the non-conforming balances right now a pretty good relative value."

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