June 1 (Bloomberg) -- Washington Mutual Inc., the biggest U.S. savings and loan, said its subprime mortgages originated this year were performing better than those issued last year due to tighter lending restrictions.

``What I've seen so far in the way of first payment defaults, early payment defaults and early delinquencies suggests materially improved performance over what we saw out of the '06 book of business,'' Chief Executive Officer Kerry Killinger said today at a Sanford C. Bernstein & Co. conference in New York. ``That would confirm the belief that we've had that underwriting standards have been improved and pricing has improved in the subprime products in '07 versus '06.''

Late payments on subprime home loans, which are made to borrowers with poor credit ratings or high debt burdens, led to 437,500 foreclosure filings in the first quarter, a 35 percent increase from a year ago, according to Irvine, California-based RealtyTrac Inc. During the period, Seattle-based Washington Mutual's home loan division posted a $113 million loss as the company took steps to reduce terms that make subprime borrowers more likely to default.

Washington Mutual said in April it expects the home loan unit to return to profitability by yearend, based in part on plans to cut back on ``layering,'' the practice in which easy qualification terms are added so borrowers can win approval.

`Somewhat Nasty'

Investors in subprime mortgage bonds are limiting losses by allowing some homeowners to maintain for a longer period of time the low initial interest rates on their adjustable-rate loans and avoid default, said Sheila Bair, chairman of the Federal Deposit Insurance Corp.

Investors next year and in 2009 will face increasing pressure to sustain borrowers' ``starter rates'' because mortgages made in 2006 with lax underwriting standards are scheduled to reset to a higher monthly payments, Bair said in an interview yesterday.

``The 2006 vintage is the weakest in terms of underwriting standards,'' Bair said. ``We are expecting 2008 and early 2009 to be somewhat nasty.'' Next year the delinquency rate on such loans may hit 30 percent, she said.

Killinger said today that about 3 percent of Washington Mutual's loan portfolio would reset this year and about 12 percent in 2008.

Accelerating Losses

``If the economy is anywhere near as weak next year as it was in the first quarter, and monthly payments ratchet up meaningfully, loan losses could accelerate sharply,'' wrote Dick Bove, an analyst at Punk Ziegel & Co. in Lutz, Florida, in a research note today. Bove rates Washington Mutual's stock ``market perform.''

Washington Mutual's 2007 results continue to be affected by a slowdown in the housing market, a deterioration of subprime loans, and an inverted yield curve in which short-term interest rates are paying higher yields than long-term rates, Killinger said.

``We are not operating at full capacity in terms of our earnings forecast right now,'' he said.

Shares of Washington Mutual rose 58 cents, or 1.3 percent, to $44.30 at 4:00 p.m. in New York Stock Exchange composite trading. The stock has fallen 2.6 percent this year compared with a 0.23 percent drop in the 24-member KBW Bank index.

To contact the reporter on this story: Elizabeth Hester in New York at ehester@bloomberg.net.

Last Updated: June 1, 2007 16:54 EDT