Though the subordination levels for senior classes in the prime jumbo residential arena have dropped steadily since 1999, improvements in the collateral quality of recent prime non-agency deals can justify the reduction, said a recent report by Salomon Smith Barney.

For the study, analysts compared trends and changes in credit support levels as well as collateral characteristics on 30-year and 15-year jumbo mortgage transactions by selected major issers. The sample covered similar periods in 1999, 2000 and 2001 and includes deals issued by Wells Fargo/Nascor, Chase and RFC's RFMSI shelf.

The results showed that average credit support for 30-year fixed-rate jumbo mortgages fell to 2.76% in the last quarter of 2001 from 4.20% in the latter half of 1999. The drop was steeper for 15-year jumbos, falling to 1.45% in the latter part of 2001 from 2.17% three years prior.

Analysts said that the significant decrease in subordination levels can be justified by favorable trends in LTV and FICO. According to the report, an average jumbo borrower in 2001, for instance, had a slightly higher FICO score of 733. This compares with 727 in 2000 and 724 in 1999. This trend is characteristic of 15-year jumbos as well.

On the LTV front, Salomon stated that industry average LTVs on a lot of pools have improved to show equity stakes of 30% to 35% -- which is sufficient to absorb losses at the high end of the market.

Aside from positive FICO and LTV results, rating agencies in the past few years have also built "extensive histories" on prime (and other) servicers. With servicer ratings in place, rating agencies can now give credit enhancement benefit (or penalty) as needed.

"Favorable trends in LTV and FICO, as well as extensive servicer ratings, have given rating agencies the justification to reduce enhancement levels in selected pools," said Peter DiMartino, a director and head of mortgage credit research at Salomon.

There are other collateral characteristics that justify the lowering of subordination levels in jumbo transactions.

Salomon said that a distinctive feature of 2001 jumbo deals is a much higher concentration of refi loans and a significantly lower share of purchase loans, a result of the length and magnitude of the refinancing boom that occurred last year. This improves collateral performance because refi mortgages have smaller risk potential due to accumulated homeowner equity.

Also, lower mortgage rates seen last year on underlying collateral could have caused the observed decline in credit support levels. Salomon said that lower WAC loans amortize quicker, resulting in a smaller likelihood of principal losses to the subordinate MBS investor.

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