In the immediate aftermath of Hurricane Katrina, home equity ABS may go through a short-term decrease in prepayments and delinquencies, according to researchers with Morgan Stanley. The researchers, using hurricane-ravaged Florida in 2004 as a guide, also plotted out four different scenarios based on the extent of the damage, which is not fully known, and its effect on subprime pools.

By way of comparison, Morgan Stanley looked at Florida after last summer's four hurricanes, and found prepayments slowed slightly in the immediate aftermath of the storms, but then climbed back after six months. Since that trend likely had to do with insurance claims being paid, the same is seen likely in Katrina-affected zones, but the insurance data is not yet available to corroborate that theory.

In response to Katrina, many subprime mortgage lenders have announced plans to allow up to three-month grace periods for repayments. As a result, Morgan Stanley said it does not expect a sudden spike in delinquencies, but instead sees a short-term slowdown. However, because delinquency rates in the affected areas have not outperformed the national average, it is possible there will be a greater difference in delinquency rates between the affected and unaffected regions after the grace period expires. There is also the chance that delinquencies could paradoxically decline, as in hurricane-ravaged Florida last year.

Loans in Katrina-affected areas, including flood-damaged ones, experienced lower historical losses than those in unaffected areas. These areas were not typically exposed to storm damage and with home price growth as high as 24% over the past four years, "it is quite possible to see a marked acceleration of losses in these areas since the degree of damage was so severe and to some extent unexpected," added researchers.

Finally, Morgan Stanley broke down Katrina's potential impact on subprime pools into four scenarios. First, should homes be completely destroyed, but are covered by flood insurance, faster prepayment rates are expected, and delinquencies and losses are expected to decrease. If flood insured homes are damaged, but repairable, slower prepayment rates are expected, as borrowers must stay in their homes but cannot refinance. Additionally, in this scenario delinquencies may rise.

If uninsured homes are damaged but repairable, slower prepayments are expected and delinquencies are expected to rise as borrowers experience financial strain from flood-related expenses. In the worst-case scenario of uninsured homes being completely destroyed, prepayments will effectively be zero, and delinquency rates will spike, eventually leading to a complete loss.

The good news is, most home-equity issuers have relatively little exposure to the affected areas, and the ones with the most exposure have the fewest deals outstanding. The major issuers, such as Countrywide Home Loans Inc., GMAC-RFC, Morgan Stanley and AmeriQuest Mortgage have less than 2% weighted average exposure to the affected areas.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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