Tuesday, October 30, 2007

Option ARM Performance

by Tanta on 10/30/2007 10:20:00 AM

Bank of America has kindly given us permission to quote from its Weekly RMBS Trading Desk Strategy Report of October 26 (not online). The subject of this report is Option ARM performance, and the results are rather grim.

While OAs are still performing better than Alt-A ARMs of the same vintage, the trends are, well, ugly. Bear in mind that the overwhelming majority of Alt-A ARMs in these two vintages have not yet experienced a rate reset (less than 10% of Alt-A ARMs in 2005-2006 had an initial fixed period of less than 3 years). So while the Alt-A ARM borrowers are making a higher payment than the OA borrowers, they are not yet experiencing payment shock.

But while OAs may be performing better than Alt-A ARMs in recent vintages, their current performance compared to past vintages of OA is gruesome. This chart and the following one break out OAs by loan size and loan purpose, and they suggest that neither factor is driving the current delinquency spike in the 2005-2006 OA vintages. It's important to remember, of course, that the pre-2005 pools of OAs are tiny compared to the later ones. According to UBS, gross issuance of securitized OA pools was $18.5 billion in 2004, $128 billion in 2005, and $175 billion in 2006.

It's hard to escape the conclusion that the "mass marketization" of the negative amortization loan product hasn't done much for its performance. BoA also reports that prepayment speeds have slowed dramatically for outstanding OAs, including those with and without prepayment penalties (or with expired prepayment penalties). That suggests that a fair number of these loans will be around long enough to test "historical" assumptions about what happens when their payments finally recast.