SCOTTSDALE, Ariz. - Rising interest rates, the emergence of so-called "Alt-B" mortgage collateral and changing borrower characteristics were all key subjects during last week's "Mortgage Update" panel at the American Securitization Forum's ASF 2004 conference.
Aside from the emergence of the Alt-B sector, several current trends were explored by panelists Eric Scholtz, executive vice president at GMAC-Residential Funding Corp., and Pramila Gupta, managing director at Moody's Investor Service. Other factors at play include declines in weighted average coupons, rising FICO scores, increased ARM issuance, increased loan-to-value ratios and the rise in first-time home buyers.
First-time borrowers, according to Gupta, present risks because of a lack of payment history and unexpected burden of payments on homeowners. For second liens, where borrowers have a first mortgage in a different pool, it is important to look at the combined LTVs on these loans, Gupta added.
Re-evaluating rating agency stress tests ensures that, as interest rates rise, coverage remains sufficient, Gupta said. In such a scenario, underwriting criteria becomes especially important because a borrower's ability to pay changes as rates rise, panelists noted. Moody's is scheduled to issue a report on this subject by late in the first quarter or early next quarter.
Another danger on the horizon is the effect of rising rates on borrowers with interest-only loans. For borrowers with loans requiring only interest payments for the first five years - which then switches to an amortization schedule - the payment shock could be heightened. It is problematic because, panelists said, these borrowers will have no equity built into their homes, limiting their refinancing options. On top of that, the tax benefit of homeownership lessens, as a diminished interest payment is a decline in deductible mortgage payments from income.
However, GMAC-RFC's Scholtz said there still may be viable ways to offer IO product that can limit the payment shock. For example, a borrower could be offered an interest-only loan but set on a payment schedule similar to a conventionally amortizing loan. Lenders will have to make sure to not end-load the IO.
A false sense of efficiency
Aside from interest rates, panelists also discussed potential problems in automated appraisals, which have blossomed over the past few years in response to mortgage volume.
Scholtz said that GMAC-RFC uses these systems solely for due-diligence purposes, and that automated appraisals will not supplant traditional appraisals at the firm. Also, GMAC-RFC typically uses more than one type of automated valuation system, indicating the importance in differentiating between the various systems. Retrospectively, lenders need to recognize which products work best - and their individual strengths and weaknesses - in order to maximize efficiency.
Of course, predatory servicing was briefly discussed by the mortgage panel, as the issue came to the forefront last year with the allegations and charges against Fairbanks Capital. Panelists said that problems arise when the interests of the investor and the asset are separated. A servicer must consider that investors are motivated to protect themselves from risk. Typically, special servicers that are not aligned with the residual interests will align themselves with the investor, which can lead to overly aggressive servicing - such as expedited foreclosures - that may benefit the top of the waterfall in the near term, but not the long-term performance of the portfolio, especially if the practices of the servicer come under investigation by the regulators.