Despite increasingly strict rhetoric from the Federal Reserve, near-record mortgage volume continues to be sustained by low initial teaser rates. But subprime mortgage lenders probably won't be able to afford the game much longer.

As of Oct. 14, the six-month forward Libor curve widened to roughly 4.7% at May 2006 from about 4.5% at that benchmark just two weeks earlier, due to continued indications from Federal Reserve Board members of further tightening to come. Meanwhile, the Mortgage Bankers Association's Purchase Index, currently at a value of 469.5, shows that home purchase activity remains near all-time high levels.

And despite 275 basis points of short-term interest rate hikes, the weighted average coupon of subprime ARMs has barely moved from mid-2004 levels, according to JPMorgan Securities. Yet, the fully indexed coupon rates on those mortgages within the same time period have climbed north of 10% from roughly 7%. At the same time, wholesale bids have dropped to 101 from at least 103 in the latter of 2005. In JPMorgan's opinion, "lenders have already been reduced to unsustainably low risk-adjusted returns and credit will be forced to contract."

Looking at the current shape of the yield curve, initial hybrid ARM rates must rise by between 50 to 75 basis points in order to restore profitability, according to JPMorgan, and, by 2007, the fully indexed rate should be above 11% in the scenario, with a teaser rate in the low 9% range.

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

http://www.asreport.com http://www.sourcemedia.com

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.