Subprime loans or loans made to borrowers with less than perfect credit from 2006 aren't just performing badly. The loans, in particular those used to back mortgage bonds, could prove to be one of the worst-performing groups yet, according to UBS.
In a conference call titled How Bad is Subprime Collateral? Tom Zimmerman, head of ABS research for UBS, and David Liu, head of mortgage credit, discussed how much higher loan delinquencies and foreclosures are for 2006 subprime loans compared with similar subprime loans from earlier years the result of deteriorating underwriting quality from lenders combined with a slower housing market.
Still, despite the adverse conditions, I guess we are a bit surprised at how fast this has unraveled, said Zimmerman. While it's not a secret that subprime collateral has performed pretty disastrously so far, he said, I must say we were a bit surprised by the magnitude with which the loans deteriorated this year.
The rate of subprime loan delinquencies of 60 days or more meaning borrowers are that far behind in their payments has climbed to about 8 percent, up from about 4.5 percent a year ago.
These 60-day plus delinquencies jumped up fairly sharply in the past few months, to 3.63 percent for the 2006 loans in October, up from 2.95 percent in September and 1.62 percent in July, according to UBS research.
Comparing loans of similar age, 2006 loans are performing worse than 2005, which are worse than 2004. In fact, given where delinquencies are now, loans from 2006 are on track to be among the worst-performing ever, along with the 2000 to 2001 years, according to UBS research.
And not only have delinquencies risen faster in 2006 than in earlier years, Liu noted in the presentation, but 2006 loans have entered the foreclosure process faster. In October 2006, the foreclosure rate was about 2 percent, while a year earlier it was 1 percent.
There are a few contributing factors that explain why 2006 subprime loans are performing worse than those from earlier years, Liu said. One factor is what's called risk layering for example, giving interest-only loans to borrowers who are not showing full documentation of their income.
The biggest picture is the risk layering is getting worse, Liu said. That is a problem of underwriting quality. In the recent past, Liu said, subprime loans made to borrowers with full documentation and to those with low documentation had similar delinquency rates because the lower documentation borrowers had higher credit scores.
Now, however, 2006 low-documentation subprime loans are showing a 3.57 percent 60-day-plus delinquency rate, while full documentation 2006 subprime loans are at 2.01 percent.
The reason, Liu said, is the low documentation loans have a greater percentage of simultaneous second-lien loans, or loans that are taken out as the same time as the primary mortgage, in what has become a common way to avoid paying mortgage insurance for borrowers who don't have at least a 20 percent downpayment.
With home price appreciation slowing and interest rates higher than they were in prior years, the opportunities for subprime borrowers to refinance their loans are also decreasing, Liu said. That may spell trouble for borrowers who in previous years would have been able to refinance their loans, or possibly sell their homes for a profit, in order to get out of financial difficulty with their mortgages.