FBR: B&C Defaults May Fall

Despite jitters about the housing market and resets of adjustable-rate mortgages, researchers at one securities firm are bravely forecasting a slight decline in the default rates for subprime mortgages by midyear 2007.

Friedman Billings Ramsey managing director Michael Youngblood is projecting that defaults on subprime loans will edge down to 6.45% by June 2007 - after rising during the previous 12 months from 5.5% to 6.9% as of June 30.

However, he is concerned the refinancing of subprime loans in 2007 could go badly if the yield curve does not remain flat.

Mr. Youngblood's optimistic forecast is based on a healthy job market and gains in wages, which means more subprime borrowers have jobs and they are earning more than a year ago. "The underlying fundamentals are very helpful for subprime," according to the managing director of research for asset-backed securities.

He also expects defaults in the Gulf Coast states will continue to decline thanks to special grants of up to $150,000 to homeowners whose homes were damaged by Hurricanes Katrina and Rita.

The default rate in New Orleans has fallen from 49% in December to 22% in June. Before Katrina, New Orleans had a default rate under 9%. FBR researchers define defaults as loans 90 days or more past due, foreclosures and real estate-owned.

Layoffs in the auto industry also contributed to rising defaults over the past year. "We believe those are settling down," Mr. Youngblood said. So far, the reset process on 2003 and 2004 originations has been generally smooth. "The widely anticipated payment shock in 2006 has not materialized," he said.

However, 2005 originations face higher hurdles. When that book of business begins to reset in 2007, borrowers with adjustable-rate mortgages will likely face a greater increase in mortgage rates than the 2003 and 2004 originations.

"First there is the question of income growth. Will it be sufficient to permit the 2/28 ARMs to refinance? We don't know the answer to that question," Mr. Youngblood said.

Second, is the shape of the yield curve what really worries the FBR managing director. "We do believe that the shape of the yield curve is one of the unacknowledged threats to subprime credit performance," Mr. Youngblood said in an interview. So long as the yield curve maintains its current shape and level, the refinancing of subprime ARMs originated in 2005 should go smoothly.

However, all bets are off if the yield curve goes back to its normal slope and borrowers have to refinance at 10.5%, instead of 8.5%. "That is an entirely different market environment," the ABS research director said. "So we are very concerned about it." (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com

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