Roughly half of all the performing mortgages that support private-label residential mortgage-backed securitizations are facing payment hikes within the next five years, according to a new report from Fitch Ratings. That is, boom-time mortgages securitized, but not by Fannie Mae and Freddie Mac.
The payment increases will be driven by changes in interest rates, expiration of interest-only periods and loan modification rate resets. And those payment increases will lead to higher default rates, Fitch said in its report.
“Default risk rises with the magnitude of a payment increase,” Fitch said. “Fitch Ratings estimates that loans with the largest future payment increases are roughly three times more likely to default than comparable loans with no payment increase.”
At particular risk are interest-only loans originated at the height of the mortgage boom. “Interest-only loans face large payment increases as their IO periods come to an end and amortization begins,” Fitch said in its report.
“As a significant number of peak-vintage 10-year IOs approach their recast over the next three years, the addition of principal will more than double the total monthly payment of many loans,” Fitch’s report continued. “A unique blend of low interest rates and shorter amortization terms has produced historically high IO payment increases.”
According to Fitch’s data, there are approximately 230,000 performing, first lien IO mortgages backing private-label RMBS. Nearly all will reach the end of their IO periods within the next three years, at which point, their monthly payments will increase as the loans begin to amortize.
Also at risk of payment shock are borrowers who have hybrid adjustable-rate mortgages. “Nearly all remaining hybrid adjustable-rate mortgages within legacy U.S. RMBS have passed their initial fixed-rate periods, and their default risk will depend on the future of short-term interest rates,” Fitch said. “Fitch projects that most non-IO ARMs will see payment increases of less than 60%, even under a stressful interest rate assumption.”
Fitch’s report also stated that the prime jumbo sector has the most exposure to future payment increases, as over one-half of prime jumbo loans are non-modified ARMs and IOs, Fitch said.
“While the volume of upcoming IO recasts is lower than that of prior periods, there are two unique characteristics of today’s remaining IOs that have combined to create higher risk relative to prior recast waves,” Fitch said in its report.
“Prior to 2012, average payment increases of IOs at recast were below 50%, while recent and projected payment increases are significantly higher,” Fitch added. “This phenomenon can be explained by the differences in interest rates and amortization terms among recasting IOs over time. The rise in payment increases starting in 2012 coincided with a decline in interest rates.”
Borrowers who have already had their loan modified won’t be immune from future rate increases either, Fitch said. “Many, but not all, loans that had their interest rate reduced as part of a mod will experience future rate increases,” Fitch said. “These scheduled interest rate step-ups are not tied to future market rates and are generally modest increases.”
Fitch said that the future projected payment increases are not expected to have a material impact on existing ratings of current securitizations. “Because Fitch’s loss expectations anticipate future payment increases and default adjustments, its ratings already reflect the increased risk,” Fitch said.
Fitch said that it expects short-term interest rates to increase steadily over the next three years before reaching a plateau at 6%.