Despite being backed by borrowers with better credit histories, prime collateral - specifically in jumbos - is facing its own set of problems.
However, the deterioration has not been as rapid as that seen in both the subprime and Alt-A sectors thus far.
In a report issued at the end of July, Fitch Ratings said that jumbo prime mortgage performance has deteriorated significantly for loans of recent vintage.
"Generally, the older the transaction, the better the performance," said Huxley Somerville, group managing director and head of Fitch's U.S. RMBS group. "Seasoned deals have more payment history and more equity build-up that dissuades borrowers from defaulting."
However, Somerville acknowledged that because of home price depreciation, the accumulated equity for seasoned loans have also decreased. For instance, Fitch found that if a house was bought in 1Q04 in California - where the largest component of the country's jumbo mortgages have been originated - the house might have increased in value by 40% by the middle of 2006. However, that equity has since been eroded by the sharp price depreciation that occurred in the state, and these borrowers are "back to the original value of their homes," said Somerville.
California and Florida are the two states that experienced the most house price appreciation and borrowers in these states needed bigger mortgages to buy homes. As such, those states are now experiencing the biggest price corrections, compared with states like Texas where house prices didn't go up as much and the "adjustment is much softer," he said.
Fitch is looking closely at roll rates for prime mortgages that have moved from being current to 30-day delinquent as the indicator for future delinquencies. "The big step is when loans move from performing to becoming delinquent," Somerville said.
"We look at 30-day delinquency roll rates over the past six months, and then project them forward another year to determine projected delinquency levels," Somerville said. "Even though prime delinquencies are much lower compared with subprime and Alt-A, the thinness of the prime credit enhancement means that any unexpected increases in delinquencies can adversely affect the ratings."
Merrill Lynch analysts, in a recent report, noted the same thing. They said that with the weighted average triple-A credit enhancement level for prime transactions less than 5%, it is probable that some triple-A bonds backed by recently originated loans will have losses.
Lowest Loss Rates
FTN Financial analyst Kevin Cavin said that, based on their analysis of MBS deals backed by jumbo, Alt-A and subprime collateral, delinquencies have been rising across the board. However, there has been a greater number of delinquencies in ARM collateral, as opposed to fixed-rate mortgage pools.
"Fixed-rate jumbos have experienced the lowest delinquencies and the lowest realized losses thus far," he said, adding that jumbo prime collateral has seen erosion of credit enhancement due to losses, but the erosion to date has been minimal.
By contrast, Alt-A ARM products have deteriorated the quickest, and have seen a sky-rocketing in delinquencies in the 60-day delinquency bucket. Cavin explained that, in their analysis, FTN normalizes delinquencies relative to credit enhancement in MBS deals. "We consider those two together and normalize, and saw that the credit enhancement in Alt-A has been eroded much more rapidly compared with prime or even subprime."
He added that in terms of states, those with the highest delinquencies and loss severities are those that have experienced the most significant decline in home prices. These include California, Florida, Arizona and Nevada. He also mentioned Michigan, where the economy is highly dependent on the auto industry, as well as Ohio.
The Future for Prime
One of the issues bound to play into jumbo prime delinquencies is the lack of available financing and the health of the real-estate market, a senior MBS observer said. This is especially true in California, where high home prices push many loans above the conforming limit. "California's market is disproportionately made up of jumbo loans, and the reality is, there's not much of market for these types of loans currently," he said.
In the aforementioned report, Merrill Lynch analysts said that they projected cumulative losses of 4% to 5% and 7% to 8% on fixed-rate and ARM 2006 vintage prime loans, respectively. These expectations are based on home prices falling an additional 10% before stabilizing. However, they said that even though they had utilized different approaches to estimate losses, a considerable amount of uncertainty remains. This is largely because of the long timeline for the estimation of prime losses.
"Changes in HPA, mortgage rates, refinancing ability, modification success, and government programs could all impact ultimate loss rates," Merrill analysts wrote.
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