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Impact of Principal Reduction on RMBS Through the Settlement: Fitch

Through the $25 billion robo-signing settlement between federal and state officials and the five largest banks - Bank of America, Citi, J.P. Morgan Chase, Wells Fargo, and Ally - $10 billion was set aside for principal reductions. According to ""Fitch Ratings"":http://www.fitchratings.com/web/en/dynamic/fitch-home.jsp, the funds set aside for writing down principal will have little impact on private label residential mortgage-backed securities (RMBS).

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Fitch stated that the private label result of principal reduction through the settlement will likely reach only 10 percent of underwater borrowers. Overall, Fitch estimates there is about $203 billion in negative equity for private-label RMBS.

Ultimately, Fitch reported that the impact on RMBS ratings will depend on ""the volume of strategic defaulters, the amount of the reduction offered, and re-default rates post modification.""

Also, Fitch pointed out that servicers are ""casting a wide net"" to seek out potentially eligible borrowers, which could lead to reduction amounts that go beyond the settlement agreement.

Thus, the impact of principal reduction will also depend on whether or not servicers continue with principal forgiveness even after settlement targets are met, Fitch stated.

RMBS losses will also depend on servicers' ability to distinguish between borrowers in need versus those who are not and the net present value (NPV) calculations used when determining eligibility.

According to analyses from Fitch, ""RMBS losses would be lower than currently expected if principal forgiveness is offered to delinquent borrowers - even if half of them re-defaulted post modification.""

On the other hand, if losses due to strategic defaults increase as well, Fitch stated the benefits would be offset, especially when larger amounts were assumed to be forgiven.

About Author: Esther Cho

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