Now that the first of the subprime ARM pools have reset into the heart of the Federal Reserve Board's quarter point rate increases, preliminary studies are showing them to be performing relatively well.
In a report last week, analysts with Credit Suisse First Boston tested a pool of 2/28 hybrid ARMs originated in 4Q02 and 1Q03, and found that the higher credit quality borrowers experienced the highest payment increase after the first rate reset. "Basically, those who can absorb it the most got hit the hardest," said Rod Dubitsky, head of ABS research for CSFB.
CSFB divided the loans it studied into three groups, starting with a "No Shock" group, which, as could be expected, experienced no shock after the first rate reset. These were borrowers, with an average loan amount of $125,455 and 589 FICO score, made up 42.7% of the group of loans studied. The "Small Shock" group, with a $150,436 average loan amount and 604 FICO, was the smallest group at 21.7% of the loans studied. Finally, the "Big Shock" group - 35.5% of the total studied - averaged a $156,574 loan size with a 614 average FICO.
Delinquencies in the "No Shock" group also declined after the first rate reset, while the "Small Shock" group experiencing a 20% increase in delinquencies and the "Big Shock" seeing a 40% increase. CSFB found that while the "Big Shock" group also has a slower cure rate, prepayments were faster after the first reset.
Dubitsky stressed that the percentage of loans in the "No Shock" group will diminish with each passing reset period. However, for the loans in these particular vintages that survived the first payment shock, roughly 3% in some cases, the worst is over, as each subsequent increase will only be as high as 2% per year. As for newer vintages, the jury is still out.
UBS also trotted out its take on the subprime ARM market, and stated that while the media and investors have expressed doubts that debt-laden borrowers can handle the payment shock associated with rate reset, the firm has "yet to see evidence to either support or refute that concern."
UBS found that, in general, the performance trend of subprime ARMs is improving. "Performance of the 2000 and 2001 vintages lagged industry averages, while the more recent 2003 and 2004 vintages outperformed by a substantial margin," wrote the analysts.
In examining delinquencies, UBS said subprime 2/28 ARMs experienced a 30% increase in delinquency rates at the first reset, while the increase in delinquencies was in the 15% to 20% range for 3/27 ARMs. The observed increase in delinquencies, however, is the result of spikes in prepayments at the 24-month reset.
In summary, the UBS analysts note that the proliferation of affordability mortgages, subprime margin compression and robust housing price appreciation continue to bail out subprime borrowers in the current market. "In other words, the real test is yet to come," they wrote.
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