NEW YORK--(BUSINESS WIRE)--The Federal Open Market Committee's (FOMC's) expectation of low interest rates through 2014, while benefiting the U.S. Prime mortgage sector, will provide little direct help to Subprime mortgage borrowers, according to Fitch Ratings. Consequently, Subprime borrowers are expected to continue to rely solely on loan modifications for any payment relief.
Driven by the Fed's and the Treasury's purchase of MBS and Treasury notes, mortgage rates dropped significantly after the onset of the financial crisis and have remained at historically low levels. Low interest rates have indirectly helped all mortgage borrowers by providing support for home prices and the economy in general.
However, Prime borrowers have benefited more than weaker borrowers. Since 2009, approximately 40% of all Prime RMBS borrowers have been able to refinance into lower-rate loans. And although a meaningful portion of the remaining Prime borrowers have been locked out of refinancing due to negative equity, an increasing majority of the borrowers currently outstanding with adjustable-rate mortgages (ARMs) has still enjoyed downward rate adjustments (on average from a 5% initial coupon to approximately 3% today).
In contrast, only 5% of Subprime RMBS borrowers have been able to voluntarily refinance since 2009. Furthermore, due to initial loan terms which maintain a minimum floor on most Subprime adjustable rates, the average coupon rate on outstanding un-modified Subprime ARM loans has only declined from 7.8% initially to 7.6% today. Given that approximately 20% of Subprime borrowers began with interest-only payments that have now started to amortize, a number of borrowers have higher monthly payments today than they did initially.
In an effort to help weaker borrowers take better advantage of low interest rates, the government recently announced a proposal to expand the Home Affordable Refinance Program (HARP) to non-GSE borrowers. The proposal faces congressional headwinds, however, given that it would increase the government's exposure to higher risk loans. As a result, the likelihood of implementation in its current form appears limited.
Consequently, loan modifications appear to remain the only path of payment relief for Subprime borrowers. To date, close to 50% of Subprime loans outstanding have had their loan terms modified at least once, with average rate cuts from 8.24% to 5.03%. However, the pace of new rate modifications has slowed as fewer remaining borrowers qualify for existing modification programs or are able to provide the needed documentation. In recent months, the percentage of borrowers receiving rate modifications is roughly 1/3 the pace experienced at the peak in 2010.
To encourage and redirect modification efforts, the government plans to enhance the Home Affordable Modification Program (HAMP) by expanding the qualification guidelines and by increasing incentives to lien holders to reduce principal on underwater borrowers. Fitch expects principal reduction modifications to make-up an increasing share of Subprime modifications going forward. To date, principal reduction modifications have experienced slightly lower re-default rates than rate-modifications, although Fitch still expects re-default rates greater than 50% on all modification types going forward.
Although collateral performance in the Subprime RMBS sector has improved significantly from the onset of the crisis, Fitch expects the rate of improvement to slow in 2012 as many remaining borrowers continue to struggle with overextended consumer debt and negative-equity in their homes. This year Fitch expects downgrades of Subprime RMBS to continue to outnumber upgrades as close to 75% of Subprime RMBS bonds remain on Outlook Negative.
Additional information is available at 'www.fitchratings.com'
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