End of Refinancing Boom May Lead to Deterioration of Loan Quality.

Over the last two years, rapidly rising home values and heavy refinancing dramatically improved the credit quality of home loans packaged into securities, according to Standard & Poor's.

High-quality borrowers locked into interest rates almost never before seen in their lifetime to refinance loans, resulting in an across-the-board increase in FICO scores and a decrease in loan-to-value ratios during the refinancing boom.

But that may be about to change, the rating agency warns. And S&P says that external factors may affect credit enhancement levels that will be applied to mortgage-backed securities.

Thomas Warrack, a managing director in S&P's residential mortgage group and author of a recent report on changes in the residential market, told Mortgage Servicing News that as the refinance boom comes to a close, the jumbo home loan business will return to more of a home purchase environment.

S&P expects collateral characteristics and credit scores to "return to a more normal range" when that happens. That would mean FICO scores should return to an average in the 710 to 720 range and loan-to-value ratios in the low to mid-70s.

Mr. Warrack said that S&P's loan-level analysis will be able to pick up even slight changes in the collateral mix that increase the risk profile of a loan pool. By contrast, the average LTV on prime transactions exceeded 730 in the second and third quarters of 2003.

"Our credit enhancement requirement will begin to go up accordingly with that change in collateral mix," Mr. Warrack said.