The underlying credit fundamentals for nonagency residential mortgage-backed securities continued to improve in June as delinquencies fell and loan modifications ticked up alongside rising home prices, Wells Fargo Securities analysts claim in a new report.

The analysts see the improvements as signs of a positive turnaround in the housing and labor markets and a substantial increase in loan modification activity, which is bringing more distressed or underwater borrowers current.

"Our outlook for the underlying credit fundamentals in the non-agency market remains positive, anticipating further recoveries in home prices in conjunction with a stable economic landscape contributing to more favorable loan performance on a go-forward basis," Wells Fargo analysts Greg Reiter, Bee Sim Koh, Mark Fontanilla and Randy Ahlgren wrote.

Delinquency rates month-over-month continued to decline in every category from the 30-days past due loan category to seriously delinquent mortgages.

In addition, prime foreclosure and REO activity remained unchanged while Option ARM, Alt-A and subprime foreclosures and REOs continued to decline from the previous report.

(Click on chart below for complete picture of collateral characteristics)

The loss severity rates for prime, subprime and option ARM loans fell to 2.4%, 1.9% and 0.2%, respectively.

Meanwhile, modification activity alone continued to grow, adding a dose of stability to the mortgages backing the securities.

Subprime loan mods alone grew by 18.2% month-over month, while prime modifications edged up 9.8%.

"Alt-A and Option ARM modifications decreased 5% and 4.5% month over month, respectively," the analysts explained.