As regulators, members of Congress and Wall Street begin to clamp down on so-called risky mortgage products within the subprime lending sector, market participants are growing increasingly concerned about the ability of borrowers currently locked into those products to refinance.
And while a number of subprime lenders have vowed to work with their customers - in some cases, by developing custom products - those lenders may not be around to do so.
"The dramatic shrinking of mortgage credit in a slowing housing market will make it the most difficult for subprime borrowers to refinance," said Larry Yang, a vice president at Credit Suisse, speaking during a conference call on the state of the subprime market earlier this month.
In the midst of robust home price appreciation and free-flowing capital, subprime lenders have used refinancing as a loss mitigation tool of sorts. If a borrower was having difficulty making mortgage payments, chances were that home price appreciation provided enough of a cushion to allow refinancing into another hybrid product justifiable for the lender.
Now, mortgage brokers are complaining about the growing list of subprime lenders that are raising minimum FICO requirements and lowering minimum loan-to-value ratios. Perhaps most prominently, a majority of lenders have slowly retracted the popular 80/20 piggy-back loan offering, as secondary market buyers became less receptive to them, and the ones that had bought them asked for their money back amid poor performance. Adding fuel to the fire, recently proposed regulatory guidance would stop the ability of lenders to approve a borrower for an adjustable-rate mortgage based only on that borrower's ability to pay the introductory rate.
Borrowers prepare to reset
While Wall Street demand for home equity loans is prone to ebb and flow depending on price, some caution that if regulators have overstepped their bounds on product restrictions, the result could be a much higher rate of delinquency and foreclosure for subprime mortgages, particularly the barrage of mortgages originated in 2006 due to reset in 2008.
Upon the release of mortgage delinquency and foreclosure data for the 4Q06, the Mortgage Bankers Association said last week that "the market is working," and warned that policy makers should let capital markets, not regulations, control product availability.
"We would continue to caution policy makers to avoid any regulatory or legislative actions that would impede the ability of the market to respond to changes in underlying economic conditions," Doug Duncan, chief economist of the MBA, said last week. "For consumers who are having or who expect that they might have difficulties making their mortgage payment, we continue to advise them to contact their lender as early as possible in order to maximize a lender's opportunity to flexibly address each homeowner's individual circumstances."
The percent of subprime ARMs more than 90 days delinquent rose to 14.4% in the fourth quarter of 2006 from 13.22% in the third quarter, according to the MBA. The ability for borrowers to roll into a new mortgage becomes even more difficult if mortgage payments have not been kept up on, and LTV ratios remain high. Roughly 10% of subprime ARMs due to reset this year and in 2008 are at least 90 days delinquent currently, and about 25% have cumulative LTVs of more than 90% - even after built up equity is factored in, according to a Lehman Brothers report issued last week.
This year, $308 billion in subprime ARMs will reset, 12% of which are more than 90 days delinquent, and 16% of which have been more than 60 days delinquent at least once; 16% of those loans have a cumulative LTV greater than 90%, according to the Lehman data. In 2008, $349 billion worth of loans are due to reset, 8% of which are currently delinquent and 12% of which have been more than 60 days late at least once; of those loans, 32% have a greater-than-90% CLTV.
Who is going to refinance?
Aware of the impending need of their own borrowers - along with the viability of their loan portfolios - subprime lenders have in the past geared up to aid their own borrowers in need of refinancing. New Century Financial Corp., for one, was working on a "wide range of modification programs" aimed at helping borrowers unable to refinance by using current product offerings to find a loan that would work for them, said Ritchie Mann, vice president of investor relations at New Century, last September during a subprime mortgage conference in Las Vegas. "We know we need a wider toolbox," Mann said at the conference. Amy Brandt, president and chief executive of General Electric's subprime lending unit WMC Mortgage Corp., said at the time a "huge wave" of its borrowers were expected to reach their ARM reset periods at the end of 2006 and the beginning of this year, but only a "minority" would not be able to refinance with them.
While sources last week said servicers would most likely hold the most discretion over whether a borrower's loan was modified - most likely by delaying the loan's reset date or rolling them into a fixed-rate product if possible - it remained unclear how far Congress would go toward offering solutions of its own.
Consumer advocacy groups last week suggested that Congress step in not only to revise subprime mortgage product offerings, but to stop overly burdened subprime borrowers from losing their homes. Senate Banking Chairman Chris Dodd said as much last week, adding that Congress should find ways to help "millions" of families facing foreclosure. Meanwhile, Housing Secretary Alphonso Jackson suggested Fannie Mae and Freddie Mac offer a helping hand to borrowers in peril.
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