Based on the size of its population of current borrowers with high LTV loans, the Jumbo RMBS sector faces greater strategic default risk than the other sectors, according to Moody’s.
Although it has by far the fewest delinquencies among outstanding loans, the Jumbo sector has the potential for the highest volatility in losses going forward, says Moody’s in its latest ResiLandscape newsletter. This is because it features a high number of current borrowers that are underwater on their mortgages and are more susceptible to default if the housing market does not turn around. In contrast, most of the weaker subprime borrowers have already defaulted, leaving less room for future loss volatility.
The subprime sector faces relatively low volatility in projected losses. The subprime sector faces the lowest potential for significant future performance deterioration because more of its weaker borrowers are already delinquent or have defaulted, leaving less room for losses to increase substantially.
The prime sector still faces strategic default risk. The Jumbo sector, in contrast, still faces the potential for a large increase in defaults. Unlike in the subprime sector, the stronger borrowers are the ones that have already left the Jumbo pools rather than the ones that remain.
Over 80% of Jumbo loans are still current, but more than half of those borrowers are underwater on their mortgages and that proportion has risen significantly over time.
Since home prices have been fairly stable over the past year, that increasing proportion of underwater borrowers likely reflects the ability of the stronger borrowers to refinance and exit the mortgage pools. Indeed, default rates among always-current borrowers have not come down as much as in the subprime sector, meaning that the pool of current borrowers has not strengthened as much over time.