Private-Label RMBS Losses to Increase, Delinquencies to Slow

by: Research Recap

As the backlog of foreclosures continues to drive down housing prices, losses on private-label residential mortgage backed securities (RMBS) will increase in 2011, says Moody’s Investors Service in its 2011 outlook report. However, the rate at which loans in securitizations become delinquent should decline during the year. Moody’s also expects RMBS issuance to remain limited in 2011 as the market awaits proposed changes to the GSEs and implementation of new legislative and regulatory rules for securitizations.

Moody’s expects the flaws in foreclosure practices that have come to light over the last several months to delay the foreclosures by three to six months. As servicers take corrective actions, costs associated with the relevant loans will increase. As the new year progresses we should get a better sense of which servicers will bear remedial foreclosure costs and to what extent and which of them will pass them on to the RMBS trusts and ultimately to investors as additional losses.

Loan modifications that include principal forgiveness will lower delinquency rates.

The expected increase in losses, but decrease in the rate at which loans become delinquent, in 2011 follows a year during which the performance of the loans backing RMBS largely stabilized, says Moody’s. As a percentage of original balance, cumulative losses from December 2009 to November 2010 for the 2005-2008 vintage deals grew to 14.9% from 11.8% for subprime pools, to 9.5% from 5.7% for Option ARM pools, to 7.9% from 5.2% for Alt-A pools, and to 1.4% from 0.6% for Jumbo pools.

Securitization costs are likely to be higher than the cost of other funding sources because of new requirements for governance mechanisms and asset verification.

Furthermore, regulatory changes may also have a hand in limiting RMBS issuance. For instance, the regulatory requirement that originators retain a 5% vertical slice of the securitization may result in originators avoiding securitization.

An additional factor weighing down on private label RMBS issuance for 2011 is the government’s extension of the higher GSE loan limit. The increased loan limit, $729,750, has already been partially responsible for shrinking the non-conforming jumbo market.

“The high cost of securitization and compliance with the increasing layers of regulation, along with the extension of the GSE loan limits, will continue to make accessing the private label RMBS market an uneconomical funding option for most mortgage lenders.” says Todd Swanson, a Moody’s Assistant Vice President-Analyst . “The transactions that do come to market will likely have a very strong credit profile as a result of high quality assets, an increased alignment of interest between issuers and investors, increased disclosure of collateral and structural information, and structural mechanisms to monitor and enforce breaches of representations and warranties.”

Investor demand, regulatory requirements and rating agency criteria are requiring these credit strengthening features, says Moody’s.

For the full report see Private-label RMBS: 2011 Outlook and 2010 Review.