Subprime Performance to Worsen

The “excellent” performance of subprime mortgage assets over the last two years will moderate as anticipated higher rates and slower home price growth will curtail cash-out refinancing and cause payment shock among some adjustable-rate mortgage borrowers, the investment analyst said in its 2006 outlook report released Tuesday.

ARMs accounted for 60% of subprime mortgages originated and securitized in 2003, while the share reached 80% as of Sept. 30, 2005 — with hybrid ARMs and hybrid interest-only ARMs dominating, Fitch said. Borrowers from 2003 vintages as well as some 2004 borrowers will be due for a rate increase next year.

ARM share with all loans, including conforming and subprime, is one-third, the Mortgage Bankers Association of America reports.

High-cost loan delinquencies may rise as much as 10 percent to 15 percent from current levels, Fitch believes. “Borrowers will experience payment increases on ARM loans … and certain borrowers will no longer have the ability to tap their homes for additional cash,” Fitch said in the report.

“Despite this, high prepayments and strong loss performance to date have allowed bond credit enhancement to build rapidly and should help protect bonds from the expected decline in loan performance,” Fitch said in an announcement. The report indicates the subprime sector’s ratings will be stable throughout the year.

The report also noted the subprime market is positioned for increased consolidation in 2006, as smaller originators “continue to feel squeezed due to high origination costs and prohibitive whole loan execution.”

In the prime and Alt-A sectors, performance is expected to be stable in the new year and ratings positive. Refinances are still expected to slow, but Fitch sees that the prospect of higher rates on ARMs will increase the percentage of refinancings into fixed rate mortgages, option ARMs and 40 year mortgages, according to the report.

Fitch expects some portion of the 2003 and 2004 subprime borrowers approaching a rate reset this year to refinance into fixed-rate mortgages with 40 year amortization schedules or into longer term ARMs, the report said.