Housing boom floating-rate mortgages face years of payment hikes-Fitch: Interest-only loans facing largest increase

Roughly half of all the performing mortgages that support private-label residential mortgage-backed securitizations are facing payment hikes within the next five years, according to a new report from Fitch Ratings. That is, boom-time mortgages securitized, but not by Fannie Mae and Freddie Mac.
The payment increases will be driven by changes in interest rates, expiration of interest-only periods and loan modification rate resets. And those payment increases will lead to higher default rates, Fitch said in its report.
“Default risk rises with the magnitude of a payment increase,” Fitch said. “Fitch Ratings estimates that loans with the largest future payment increases are roughly three times more likely to default than comparable loans with no payment increase.”
At particular risk are interest-only loans originated at the height of the mortgage boom. “Interest-only loans face large payment increases as their IO periods come to an end and amortization begins,” Fitch said in its report.
“As a significant number of peak-vintage 10-year IOs approach their recast over the next three years, the addition of principal will more than double the total monthly payment of many loans,” Fitch’s report continued. “A unique blend of low interest rates and shorter amortization terms has produced historically high IO payment increases.”
According to Fitch’s data, there are approximately 230,000 performing, first lien IO mortgages backing private-label RMBS. Nearly all will reach the end of their IO periods within the next three years, at which point, their monthly payments will increase as the loans begin to amortize.
Also at risk of payment shock are borrowers who have hybrid adjustable-rate mortgages. “Nearly all remaining hybrid adjustable-rate mortgages within legacy U.S. RMBS have passed their initial fixed-rate periods, and their default risk will depend on the future of short-term interest rates,” Fitch said. “Fitch projects that most non-IO ARMs will see payment increases of less than 60%, even under a stressful interest rate assumption.”
Fitch’s report also stated that the prime jumbo sector has the most exposure to future payment increases, as over one-half of prime jumbo loans are non-modified ARMs and IOs, Fitch said.
“While the volume of upcoming IO recasts is lower than that of prior periods, there are two unique characteristics of today’s remaining IOs that have combined to create higher risk relative to prior recast waves,” Fitch said in its report.
“Prior to 2012, average payment increases of IOs at recast were below 50%, while recent and projected payment increases are significantly higher,” Fitch added. “This phenomenon can be explained by the differences in interest rates and amortization terms among recasting IOs over time. The rise in payment increases starting in 2012 coincided with a decline in interest rates.”
Borrowers who have already had their loan modified won’t be immune from future rate increases either, Fitch said. “Many, but not all, loans that had their interest rate reduced as part of a mod will experience future rate increases,” Fitch said. “These scheduled interest rate step-ups are not tied to future market rates and are generally modest increases.”
Fitch said that the future projected payment increases are not expected to have a material impact on existing ratings of current securitizations. “Because Fitch’s loss expectations anticipate future payment increases and default adjustments, its ratings already reflect the increased risk,” Fitch said.
Fitch said that it expects short-term interest rates to increase steadily over the next three years before reaching a plateau at 6%.

Moderation in the housing market is now in its 11th straight month, according to the latest home data index from Clear Capital.

National home price gains fell to 6.7% year-over-year and 1.0% quarter-over-quarter.
 Meanwhile Distressed Saturation fell to just 16.8% suggesting the shortage of lower priced inventory is the catalyst for stalling gains. National trends were echoed at the regional level, with the West seeing the strongest moderation across the country. In fact, for the first time since the start of the recovery three years ago, the West’s yearly rates of growth fell below 10%, a sure sign of more moderation to come over the next several months for the nation.
“Performing-only sale trends are a bellwether for what’s to come in 2015 ” said Dr. Alex Villacorta, vice president of research and analytics at Clear Capital. “Think of home price growth since the housing collapse as a bouncing ball, where each successive bounce causes some energy to be lost and eventually movement stalls. We see this on a few different levels. First, we see the delta between performing-only and all sales, including distressed sales, merging. This confirms markets are no longer driven as much by investor demand for discounted distressed assets.”
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Cash buyers competing for distressed and low-tier inventory helped to jump start the overall recovery, while supporting healthy price growth in this segment. At the height of the recovery in 2013, national prices including distressed sales (the all sale segment of the Clear Capital HDI) outperformed the performing-only sale segment of the market by 4.2 percentage points.
“Now the all sale segment is outperforming the performing-only sale segment by 3 percentage points. These segments’ rates of growth will likely continue to fall in line with each other as investor engagement dwindles—a result of fewer distressed sale opportunities. As this occurs, markets will be more reliant on performing-only sale demand and price growth,” Clear Capital’s report says.
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They also warn that improvements in the broader economic landscape have not instilled confidence in traditional homebuyers (first-time, move-up, second home owners). The general lack of demand in the performing-only segment, coupled with a dwindling supply of distressed inventory, leaves the future of home prices squarely in the hands of traditional homebuyers, who have yet to show any signs of re-engaging.
Performing-only sales are not yet strong enough to support recovery-sized market growth without distressed sales. It’s been a steady descent for national yearly rates of growth. They have dropped five percentage points from a high of 11.7% in December 2013.
“We see notable weakness in the performing-only sale segment, a sign that non investor buyers are not engaged enough to support the recovery. As markets continue to normalize, we’ll see reduced growth from the distressed segment, which is a good thing for the market overall as the legacy of the housing crisis fades in the rear-view,” Villacort said.  “Yet, should national rates of growth turn to losses as a result, non investor homebuyers will likely further disengage. Quarterly losses could snowball into yearly losses, and create a negative feedback loop. At this point, the market showing signs of weakness is a cause for concern.”
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While this is healthy for markets overall, the weakness of price growth in the performing-only segment is further cause for concern. Excluding distressed sales, performing-only national home price growth over the last year was just 4.4%, down from a recovery high of 7.2%. Even more concerning is the performing-only segment’s drop in quarterly growth to 0.6%, nearly cut in half over the last rolling quarter which saw quarterly rates of growth at 1.1%.
Reduced reliance on distressed sales and diminishing gains in the performing-only sale segment  could be too much for the recovery to overcome as we enter winter. The recovery is at a tipping point. Markets need non investor demand to ramp up, and homebuyer confidence restored. Should this turn into a negative feedback loop, the likelihood for quarterly price declines at the national level could turn into yearly price declines by the end of 2015.