Fitch Revises Its Stance on AVMs
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Alternative valuation methods such as automated valuation models (AVMs), drive-by
appraisals, and broker price opinions (BPOs) for newly originated first lien mortgages will no longer be subject to a reduced property valuation based on the location of the property according to Fitch Ratings in the latest edition of ‘Mortgage Principles and Interest’.
Previously, for lenders’ processes reviewed by Fitch, Fitch discounted non-full appraisal values by 10-15% for properties located in regions considered to be soft or weak by Fitch. This approach was based on Fitch’s concern that AVM data might significantly lag the market in these regions. Fitch has conducted research on AVMs and concluded that there is no significant lag. Fitch will evaluate each lender’s processes and controls for its AVM and other non-full appraisal usage as a sole valuation tool for new first lien originations to ensure that overvaluation risk is adequately mitigated, according to Senior Director Suzanne Mistretta.
‘If, based on Fitch’s evaluation, a lender’s non-full appraisal program could potentially increase a pool’s loss exposure, Fitch will discount property values 5% or more for each loan that does not have a full appraisal, irrespective of its location,’ said Mistretta. ‘Fitch will also apply the same discount to lenders who do not disclose their non-full appraisal guidelines and methodologies.’
The newsletter also includes Fitch’s approach for rating prime and Alt-A hybrid ARM and fixed rate interest-only mortgages (IOs).
Prime and Alt-A hybrid adjustable rate mortgages (ARMs) with 10-year interest only periods have a low risk of default due to payment shock relative to many of the affordability products available today. Though the payment increase at the rate reset and amortization start date is substantial, Fitch believes that borrowers of 10 year interest only mortgages (IOs) have sufficient time to refinance the mortgage, sell the home, or increase their income before incurring the payment increase. This is also true for hybrid ARMs with a seven year IO.
‘Fixed-rate IOs present an even lower risk of default since there is no interest rate risk; the note rate remains unchanged for the life of the loan and the payment increase is made up of only principal’ according to Mistretta. ‘Fitch believes that performance is likely to trend closely to 30-year fixed rate mortgages (FRMs) and, therefore, depend primarily on the borrowers’ credit risk profile and other risk attributes such as the presence of second liens, documentation standards, occupancy and loan purpose.’
Fitch’s opinion is based on several factors. First, today’s fixed rate IO coupon rates are less than 10 basis points (bps) higher than 30 yr FRMs, so the borrower is not paying much more for the interest only feature. Also, the payment increase is smaller than the amount from the rate reset and occurs after 10 years.