With affordability mortgage products on the rise, one sector that has seen considerable growth is piggyback loans. The higher LTV associated with these loans implies greater credit risk, analysts said.
Glenn Costello, a managing director at Fitch Ratings, explained that since second-lien borrowers have close to 100% LTV, the lack of accumulated equity therefore restricts their ability to maintain or improve their homes. Additionally, the loss severity is higher for second-lien loans.
In a recent report, Nomura Securities explained that the same lender generally originates both loans. Piggyback loans, said Nomura, have also been referred to as 80-10-10 loans, broken into a first mortgage (80%), a second mortgage (10%), and a down payment (10%). Through this structure, borrowers avoid private mortgage insurance premiums even with less cash down, which could, as a result, lower the borrower's monthly payment. Additionally, interest payments from a second mortgage are tax deductible.
Fitch's Costello said there had previously been less disclosure of piggyback seconds, as buyers of first lien loans were usually not informed of their presence. This has changed recently, however, with increased disclosure. Fitch is now able to accurately compute the combined LTV of both the first and second liens to calculate the first mortgage's default risk. Costello added that Fitch also looks at increased concentrations of first-lien purchase loans, making conservative assumptions to factor in this incremental risk.
In a recent report, Dominion Bond Rating Service analysts noted that the piggyback mortgages have grown to 25% to 30% of mortgage pools from 5% in the last couple of years. DBRS analysts said that, like other affordability products, borrowers taking out piggyback mortgages are likely over-extended. Although borrowers may have higher FICO scores, the higher debt-to-income ratios and likelihood of IO first-lien, hybrid ARMs or stated documentation mortgages make risk layering more rampant in the product.
"Though equally dominant in both the prime and subprime sectors, piggyback borrowers in the subprime sector worry us more," said Quincy Tang, senior vice president at DBRS, explaining that, borrower behavior in prime pools is more rational as these borrowers are generally more credit savvy while subprime borrowers tend to over leverage themselves.
Tang added that an 80% LTV first lien with a piggyback will exhibit higher default frequency versus a standalone 80% LTV loan. "A piggyback first is closer to a 100% LTV loan than an 80% LTV loan," explained Tang. She added, however, that a piggyback first would have a slightly lower default frequency, as borrowers are motivated to pay off the higher coupon second lien quicker.
Although piggyback reporting has improved greatly, there are still a few lenders lacking the technical know-how to track them. This is why DBRS assumes that all 75% to 80% LTV purchase mortgages have simultaneous seconds unless data to the contrary is provided. "We believe that piggyback loans may actually comprise 10% to 40% of a pool," said Bernard Maas, a vice president at DBRS.
Citing published reports, Nomura analysts stated that high-LTV loans, including piggybacks tend to be concentrated in high home price depreciation risk areas. In these regions, "stretching" becomes necessary, specifically when home prices have increased at multiples above personal income growth. Rising interest rates become especially detrimental if the second lien is a HELOC as revolving loans typically have higher caps than traditional ARMs and adjust monthly rather than annually, further magnifying the impact of rapidly rising rates.
Investors, according to Nomura, often worry about the lack of disclosure on second mortgages, also called silent seconds. This happens when a first lien is sold without specifying that a second lien is attached to the same property, causing investors to assume that they are purchasing an 80% LTV loan when the actual risks are much higher. Furthermore, loss severities on second mortgages tend to be higher versus first mortgages since the second lien only has a "tenuous claim on the collateral." So if piggyback borrowers experience financial difficulty, they would probably prioritize the first mortgage and if a sale occurs after a drop in property values, this might not be able to cover both liens. Second mortgage deals require greater credit support levels versus other mortgage products due to the perceived risk, Nomura added.
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