It is interesting that after an initial downdraft, conforming fixed mortgage rates remain high relative to other rates (such as 10-year Treasury yields).  Given the consolidation in the lending industry experienced over the past few years, loan pricing will increasingly reflect oligopoly pricing.  (This is similar to what the airline industry has done for years; pricing is done with one eye planted firmly on the competition.)  This suggests that mortgage rates will probably be quite sticky on the way down; with reduced capacity and less competition among lenders, lenders aren't worried about losing business by keeping their pricing relatively high.

One interesting thing of note is that some indicators (such as Bankrate.com) suggest that fixed jumbo rates have dropped much more than conforming rates.  It's not clear whether this is the beginning of a trend or reflects some oddities of the survey methodologies, as there appears to be a great disparity of offerings.  For example, Kinecta Federal Credit Union is quoting a 0-point rate at 6.625%, while Countrywide (i.e., Bank of America) was offering fixed-rate jumbo loans around 8% with 1 ¼ points at the same time.  An interesting clue was in a story in the L.A Times' Sunday real estate section (pointed out by the observant Bill Lewis, President of ChoiceOne Mortgage) which discussed how a number of large lenders are rolling out more aggressive jumbo financing; according to the story, Countrywide will be unveiling a program to write fixed-rate jumbo loans in the upper-5% area.  The story also indicates that loans will be held in portfolio, not written for securitization (a good thing, since there currently is no non-agency MBS market).   This could be a huge stimulant for home prices in California, where home prices in many markets are well above the conforming limits.

In this week's Forums, there is a discussion on alt-A and option-ARMs resets.  With respect to alt-A ARMs, there are a lot of different products; after years of abuse and misuse, "alt-A" can range from reduced-documentation prime loans to high-grade subprime.  The higher end of the alt-A ARM market probably won't experience much in the way of reset issues as long as money-market rates remain around current levels.  Most of these programs had gross margins in the area of 225 basis points; with one-year LIBOR around 2%, many loans experiencing a reset will have a decrease in rate, at least for the next year.  

The story is similar for subprime and low-grade alt-A loans.  A lot of these products had start ("teaser) rates in the area of 7-8%, but with reset margins as high as 700-800 basis points.  This looked like a looming disaster at the end of 2007, when LIBOR was in the area of 5%; however, the Fed's concerted action to push short rates down meant that most loans will reset around their teaser rates.

Option ARMs are a different story.  A lot of worries in this sector stem from automatic recasts (i.e., the loan is recalculated to pay as a one-year ARM at the prevailing rate amortizing to the remaining term).  While these loans can be exceedingly complex, they have a few critical features.

The loans have an initial teaser rate, typically 1.0-1.5%.  This rate dictates the "minimum payment" that a borrower is allowed to make, subject to annual adjustments.  After the teaser period (typically one or three months), interest is calculated at the "accrual rate," i.e., the reset margin (normally 200-350 basis points) plus the index (usually 12-month MTA, a moving average of one-year Constant Maturity Treasury quotes).  Borrowers can continue to make the minimum payment and have the "deferred interest" (i.e., the difference between the interest accrued and paid) added to the balance.  Any payment in excess of the minimum reduces the deferred interest; payments in excess of the interest due amortize the loan's principal.  

One common misconception is that borrowers have a menu of four different payments that can be made.  In actuality, they can pay any amount equal to or greater than the minimum payment; the four options are shown on the statement to make the product somewhat comprehensible to borrowers.

All loans have limits on how much "negative amortization" (or "neg-am") can take place, with a typical cap being 115%.  The loans are also designed to "recast" at some point, either when the neg-am cap is reached or at a pre-designated point in time.   At the recast, they effectively become one-year ARMs to the remaining term.  Early vintages commonly had 5-year recasts, while loans originated after mid-2005 typically recast after ten years.  

One interesting factoid is that the amount of negative amortization accrued varies, depending on the level of the index.  When MTA was at its peak of around 5% in April 2007, borrowers making a minimum payment would negatively amortize at a rate of about 3.5% per year.  However, when rates are low (as they are now, with MTA just over 1.5%) borrowers making a minimum payment may actually amortize their loans, since the minimum payment is calculated as a fully-amortizing payment (i.e., not an interest-only amount).

A review of the deal remittance reports indicates that deals originated after 2005 exhibit a huge falloff in performance.  This is attributable to a few different factors:  underwriting quality declined, and better loans were, in many cases, sold off and/or held in whole-loan form by depositories and REITs.  In addition, loans from the 2006-2007 vintage have experienced the greatest home price depreciation; combined with the large amounts of negative amortization typical for this vintage, many borrowers owe much more on their loans than the market value of their properties.

The outlook for the product's performance is a good news/bad news proposition for the two generations of the product:

2004-2005
Bad news:  Most of these loans were 5-year recasts, which are beginning to come due.
Good news:  They will reset to relatively low rates, and they were underwritten better (i.e., higher credit scores, lower LTVs, less stated income, etc.)

2006-2007
Bad news:  1) They were underwritten horribly; 2) the combination of high LTVs and sliding real estate values has put huge numbers of loans deep under water.
Good news:  Most loans from this era had 10-year recasts.  With MTA at current levels (and likely dropping below 1% by the fall) borrowers can continue to make minimum payments and not negatively amortize their loans.  If borrowers can make their payments (obviously not a given in the current environment), they can muddle through for a while.

One other note:  the presence of large numbers of ARMs with weak credit and high LTVs (making them unlikely candidates for refinancings) puts added pressure on the Fed to keep short rates low.  This will limit the Fed's ability to tighten credit for quite a while, which could be quite inflationary.  The Fed will need to keep a close eye on the size and composition of the ARM market; too quick an increase in short rates could negatively impact a lot of borrowers.  An alternative would be a government program designed specifically to refi borrowers out of ARMs.