Option ARMs Surpass Subprime Mortgages in Loss Severity
Higher delinquency levels and loan loss severities characterized private-label mortgage credit performance in 2009, Moody's Investors Service said in a 2010 outlook report this week. The slipping performance was pronounced in pay-option adjustable-rate mortgages (option ARMs), pushing revised loan loss severities in this sector higher than that of subprime. The growing pain in option ARM performance is the cover of a HousingWire magazine issue out now, which studies the effect of $134bn of option ARMs expected to recast into higher monthly payments over the next two years. During the weak performance seen in 2009, Moody's took rating actions on nearly 45,000 (residential mortgage-backed securities) RMBS transactions related to the 2000 to 2009 vintages. As delinquencies rise and home values decline, Moody's continues to revise its loss projections in the RMBS. Moody's does not expect a bottoming of house prices before Q310, with another 11% national decline likely before the worst is over. These price declines, taken with rising unemployment, housing inventory oversupply and weak demand, are pressuring performance. On the heels of longer foreclosure and liquidation time lines "exacerbated by unsuccessful modification efforts" in 2009, loan loss severities worsened across all sectors, according to Moody's. Option ARMs have surpassed subprime as the sector with the steepest loss projections for securities issued from 2005 to 2007, according to Moody's. The rating agency now expects a 20% cumulative loss on '05 option ARM RMBS (from 11.7% in Q109), 41% on '06 securitizations (from 26.7%) and 51% on '07 securitizations (from 29.7%). As a result of these revisions, Moody's is reviewing 2,553 tranches of option ARM RMBS with an original balance of $322bn - now $196bn outstanding - for possible downgrade. The updated projections should have the greatest impact on '05 securities, Moody's said. Delinquencies of 60 or more days, assets in foreclosure or held-for-sale rose "markedly" since the last Moody's revision to option ARM RMBS projections in Q109. Serious delinquencies rose to 40.4% from 33.3% for '05 securities, to 47.3% from 38.6% for '06 securities and to 41.3% from 30.4% for '07 securities. To revise its loss projections, Moody's estimated the growth of these delinquency rates through the second half of 2010, based on recent performance. The rating agency then applied a reduction to the growth in delinquency through 2013 and beyond, based on home price and unemployment projections on improving economic and housing conditions. Subprime RMBS for '05-'07 bears the second-highest loss severity projection based on delinquencies (illustrated below). Moody's projects cumulative losses at 18.7% for '05 subprime RMBS (from 13% in Q109), 38.4% for '06 securities (from 30%) and 48.1% for '07 securities (from 36%). Write to Diana Golobay.