'Risk Layering' Called Overblown
While regulators and industry watchdogs have been highlighting the "layering" of risk in interest-only loan products, analysts at Friedman Billings Ramsey & Co. say the threat is overblown.
With regard to subprime credit-quality loans that have been securitized, FBR said its research finds that "a very small proportion" of loans are affected by risk layering that compounds the possibility of default. Furthermore, FBR says the loans that are affected by risk layering are not concentrated in any particular metropolitan area.
FBR, defining "risk layering" as the combination of two or more loan characteristics that could increase default risk, focuses on the layering of risk factors such as loan-to-value ratios in excess of 80%, debt to income ratios exceeding 39%, credit scores below 620, cash-out refinancing, simultaneously originated second-lien loans, teaser rates and alternative documentation among interest-only, subprime loans.
In the securitized interest-only market, FBR found that 16.6% of interest-only loans had two or more risk factors "layered" on top of each other.
Surprisingly, FBR analysts say that the credit performance of interest-only subprime loans "generally continues to surpass that of fully amortizing subprime loans."
In fact, FBR analysts Michael Youngblood and Jason Hu said they could barely distinguish between the performance characteristics of interest-only and fully amortizing loans.
Default rates, cumulative loss rates and loss severity rates were greater for fully amortizing loans than for interest-only subprime loans, according to FBR. The analysts said the significantly higher weighted average credit score for interest-only loans at 656 vs. a weighted average FICO score of 618 for fully amortizing loans, is probably a big factor in the difference.
Overall, the FBR analysts said that evidence suggests lenders are "underwriting interest-only loans prudently."
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