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$47bn of Interest-Only RMBS Loans to Recast This Year, Fitch Says

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More than $47bn of collateral backing prime and Alt-A residential mortgage-backed securities (RMBS) is scheduled to recast over the next 12 months from an interest-only (IO) payment to a fully amortizing payment, Fitch Ratings said in market commentary Monday. These recast events should increase monthly payments by 15% on average, and possibly higher if rates also rise. The effect of higher expected defaults on IO loans figures to be relatively small on the overall market, as these loans account for only 8% of the securitized non-agency market. But individual RMBS transactions with high concentrations of IO loans will feel relatively more pain. "It was not uncommon to see IO concentrations of greater than 50% in certain securitizations," Fitch said. "Performance on these pools will be particularly hard-hit by recasts" and potentially lead to negative pressure on long-term ratings. IO features were available on both fixed- and adjustable-rate mortgage (FRM and ARM) products; fixed-rate IO borrowers face a payment increase equal to an amount of principal amortization when the IO period ends, with the payment remaining fixed afterward for the life of the loan. ARM IOs have an interest rate risk, where the payment can increase based on prevailing interest rates at the date of reset. While ARM IOs that reset in the present environment will only face an increase from principal amortization, these payments will be subject to future increases if rates rise on subsequent reset dates. Interest-only options are popular not only among borrowers in terms of payment, but are growing increasingly popular among non-traditional investors as a type of security. The difference is, as interest rates rise, borrowers with interest-only loans are pressured, but investors in interest-only securities gain. As HousingWire reported over the weekend, market commentary from Barclays Capital (BarCap) on Friday noted a recent trend of increased interest from non-traditional investors in interest-only (IO) securities. IOs are agency collateralized mortgage obligations (CMOs) that are split off from agency pass-throughs. The other CMO created in the process is the principal-only (PO) security. The price and yield of IOs tend to increase as interest rates rise, causing prepayments to slow. The price of IOs rising with higher rates marks a stark opposite of the behavior of many fixed-income securities. This makes IOs effective particularly for hedging portfolio risk, BarCap researchers note. Write to Diana Golobay.

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