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Fitch Sees Drop in Subprime Delinquencies as Default Swap Prices Rise

Recent improvements in the job market are translating into falling subprime delinquency rates, according to ""Fitch Solutions"":http://www.fitchsolutions.com. At the same time, prices on U.S. subprime credit-default swaps (CDS) have been steadily rising, up for five consecutive months.

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Multiple reports on the secondary market signal growing investor appetite for subprime mortgage bonds and structured finance instruments like CDS, which provide a type of insurance protection for investors in which the risk of default is transferred from the holder of the security bond to the seller of the swap.

While subprime bonds have become the black eye of the mortgage industry, these high-risk loan pools offer high yields, and therein lies the attraction for investors.

According to a _Wall Street Journal_ report, prices within the subprime bond market have doubled from 30 cents on the dollar at the low point of the crisis to roughly 60 cents today.

Fitch says it's also seeing a rate of increase in prices of subprime default swaps that's equivalent to a ""rally.""

The agency's overall subprime CDS price index rose 5.8 percent in March to hit its highest level since October 2008. Fitch says the 2004 vintage led the charge with a 9.4 percent monthly increase, followed by the 2007 vintage which registered a 6.7 percent gain in March.

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Rising subprime prices and the increased investor interest stems from a noticeable improvement in credit performance for these high-risk mortgages.

Fitch reports that the percentage of subprime borrowers who were 30-days delinquent decreased by 5.3 percent in March, while the percentage of borrowers 60-days delinquent fell by 4.4 percent.

Additionally, the firm found that fewer subprime borrowers are rolling from the early stages of delinquency to the later, and there has been an increase in cured loans from previously delinquent borrowers.

Fitch notes that the 2004 vintage saw a sharp increase in cured loans with the percentage of 60-day delinquent borrowers who rolled to current increasing by 50 percent and the percentage of 30-day delinquent borrowers who rolled to current up by 30 percent.

According to Fitch, the area that is most likely to weigh on subprime prices going forward is the increasing amount of time needed to sell foreclosed or real estate owned homes.

""Homes in foreclosure remain near record highs, while foreclosed homes sold each month continue to decline,"" said Alexander Reyngold, senior director at Fitch Solutions. ""Loan loss severities have increased proportionally to the time required for the loan to be liquidated over the last year.""

Reyngold explained that the resulting increase in loss severities can lead to lower CDS prices as losses to the reference bond also accrue to the CDS.

As an example, for the 2007 vintage, the percentage of foreclosed homes was 19.8 percent, almost unchanged from the previous year, according to Fitch's report.

However, the percentage of loans rolling from foreclosure or REO to liquidation was half the rate of a year ago at 2.5 percent.

As a result, Fitch says over the same period, loss severities on foreclosed or REO homes rose from 70 percent to 77 percent.

About Author: Carrie Bay

Carrie Bay is a freelance writer for DS News and its sister publication MReport. She served as online editor for DSNews.com from 2008 through 2011. Prior to joining DS News and the Five Star organization, she managed public relations, marketing, and media relations initiatives for several B2B companies in the financial services, technology, and telecommunications industries. She also wrote for retail and nonprofit organizations upon graduating from Texas A&M University with degrees in journalism and English.
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