Interest-only mortgages are increasingly infiltrating fixed-rate securitizations, said analysts, and although IO concentration has been limited in fixed-rate MBS so far, factors, such as the increase in borrower demand, the convergence in IO and fully amortizing loan valuations and growing investor appetite, are expected to bolster their presence in fixed-rate deals going forward.
"Concentration of IO loans has been substantially low in fixed-rate securitizations, less than 10% in Alt-As and negligible in the prime sector," said Satish Mansukhani, head of mortgage strategy at Credit Suisse First Boston, noting that the IO share has been significantly higher - closer to 80% - in hybrid ARM securitizations.
In a recent report, CSFB analysts note that price paybacks on fixed-rate IOs have narrowed to four to six ticks on conforming balance, and six to eight ticks on non-conforming balance prime jumbo and Alt-A fixed-rate structures, which are roughly one point back of fully amortizing loans. Furthermore, CSFB said that IO share in fixed-rate MBS deals had previously been only 5% per deal, but has risen to as much as 10% on some transactions, resulting in carve-outs within fixed-rate transactions backed, in some instances, entirely by IO loans.
Analysts also examined historical prepayment experience in IOs and amortizing mortgages, recognizing that borrowers are either "refinancers" or "switchers" and that there has been a shift in borrower psychology from "rate" to "payment." Refinancers limit refinancing vehicles to the existing product displaying rate optimization while "switchers" maximize options by switching across product types.
"Historical prepayments reveal better to comparable convexity profiles on IOs versus fully amortizing loans," according to CSFB analysts, noting slower peak speeds responding to high refinance incentives offset stronger lock-in rates, inhibiting turnover when out-of-the-money. Researchers added that this is in contrast to conventional wisdom suggesting a worse convexity profile on IOs exhibited through greater lock-in and faster speeds in response to lower rates. Borrowers switching from non-IO loans to IOs cause faster speeds on non-IOs in low rate environments, a phenomenon largely driven by the novelty of the IO product.
In terms of defaults, CSFB reported that historical default performance has been better on fixed-rate IOs versus fully amortizing loans, while default buildup is comparable to the 2004 vintage. This phenomenon results from the convergence in IO and amortizing loan collateral characteristics.
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