Home prices and mortgage delinquencies appear to be stabilizing, but how well U.S. residential mortgage backed-securities (RMBS) issued before 2008 perform will depend on three key variables, according to a ""Standard and Poor's"":http://www.standardandpoors.com/SPComIPResolver report.
[IMAGE]Those three variables are ""collateral performance, the effectiveness of structural protections, and the behavior of key transaction parties like servicers and bond trustees.""
Collateral performance
The impact of collateral performance on RMBS was examined by looking at a variety factors including the rate at which current or delinquent loans move into the next stage of delinquency, lengthening liquidation timelines, and redefault rates.
According to the ratings agency, the rate of loans moving from current to the 30-day delinquency stage has slowed due to an increase in mortgage modifications. However, the rate of loans that move from delinquent to performing ""remains depressed"" since many borrowers are not eligible for certain modifications.
The ratings agency also believes that some of the borrowers who are current on their mortgages now may become delinquent in the future if they have little or no equity in their homes, but stated redefault rates on modified loans have been declining over 12 months.
Also, the percentage of modifications that included a principal reduction has risen for prime and Alt-A loans, an increase that was attributed to various government modification programs and the landmark $25 billion robo-signing settlement that included $10 billion in principal reductions from the five largest banks.
[COLUMN_BREAK]Since 2009, 7 percent of loan modifications included principal reduction and the highest percentage included rate reduction (48 percent).
""We believe this very likely reflects the maturing and streamlining of available modification programs. While principal reductions are a fairly new phenomenon, early indications suggest that they yield lower redefault rates than other modification types,"" S&P stated.
Still, while redefault rates have been declining, they're still in the 20 to 30 percentile range, meaning one out of every 5 borrowers who is modified is likely to default, which is relatively high, the ratings agency explained in the report.
Structural protections
Aside from collateral trends that may affect RMBS, the report noted that the time to foreclose on properties has increased for private-label pools, possibly due to a combination of a complex foreclosure process and the number of distressed borrowers. These extended foreclosure timelines can lead to delays in losses for RMBS.
The agency report also discussed the impact of tail risk, meaning the risk a transaction is subject to toward the end of its life. This, the agency explained, is most relevant in RMBS when the number of loans in a transaction's pool becomes relatively small since the impact of a credit strain on the rated notes is greater with fewer loans in the pool.
""Some transactions that had been performing generally well have experienced adverse rating changes when one or more loans become delinquent and are liquidated,"" S&P stated.
Transaction Party Behavior
S&P stated it took rating actions on deals that had interest shortfalls, or interest that remained unpaid after loan payments were made, earlier this year. The shortfalls, in some cases, were the direct result of servicing advances made for borrowers behind on payments. Servicer advancing has been on the decline while delinquencies have gone up. The agency stated it believes this is due to the drop in home prices and increase in delinquencies, causing servicers to conclude that they won't be able to recapture the advances they provide.