On July 10, Standard & Poor's Ratings Services placed its credit ratings on 612 classes of residential mortgage-backed securities (RMBS) backed by U.S. subprime collateral on CreditWatch with negative implications. The affected classes total approximately $12.078 billion in rated securities, which represents 2.13% of the $565.3 billion in U.S. RMBS rated by Standard & Poor's between the fourth quarter of 2005 and the fourth quarter of 2006. A list of the issuers of the RMBS securities in question appears at the end of this article.
Beginning in the next few days, we expect that the majority of the ratings on the classes that have been placed on CreditWatch negative will be downgraded. We will lower our rating:
• To CCC on any class that does not pass our stress test scenario (a class is expected to experience a principal write-down or, with respect to the senior classes, a principal shortfall) within 12 months, regardless of its current rating;
• To B on any class that does not pass our stress test scenario within 13 to 24 months;
• To BB on any class that does not pass our stress test scenario within 25 to 30 months; and
• To BBB on any class that does not pass our stress test scenario within 31 to 36 months.
The CreditWatch actions are being taken at this time because of poor collateral performance, our expectation of increasing losses on the underlying collateral pools, the consequent reduction of credit support, and changes that will be implemented with respect to the methodology for rating new transactions. Many of the classes issued in late 2005 and much of 2006 now have sufficient seasoning to evidence delinquency, default, and loss trend lines that are indicative of weak, future credit performance. The levels of loss continue to exceed historical precedents and our initial expectations.
No Signs of Abating
We are also conducting a review of collateralized-debt obligations (CDO) ratings where the underlying portfolio contains any of the affected securities subject to these rating actions.
We have been watching these transactions on a regular basis and have been monitoring market trends. At this time, we do not foresee the poor performance abating. Loss rates, which are being fueled by shifting patterns in loss behavior and further evidence of lower underwriting standards and misrepresentations in the mortgage market, remain in excess of historical precedents and our initial assumptions.
New data reveal that delinquencies and foreclosures continue to accumulate at an increasing rate for the 2006 vintage. We see poor performance of loans, early payment defaults, and increasing levels of delinquencies and losses.
Total aggregate losses on all subprime transactions issued since the fourth quarter of 2005 is 29 basis points, compared to seven basis points for similar transactions issued in 2000. Transactions from the 2000 vintage are used as a comparison because they were, until now, the worst performing vintage of this decade. When recent transactions with the same seasoning are compared on a quarterly basis with similar transactions issued in 2000, we find that both mean losses and standard deviations are running in excess of the 2000 book for the fourth quarter of 2005 through the fourth quarter of 2006.
Weakness in Property Market
Seriously delinquent loans (90 days-plus, foreclosure, and real estate-owned) on average also exceed the 2000 book of business for each quarterly comparison except for the fourth quarter of 2005.
On a macroeconomic level, we expect that the U.S. housing market, especially the subprime sector, will continue to decline before it improves, and home prices will continue to come under stress. Weakness in the property markets continues to exacerbate losses, with little prospect for improvement in the near term. Furthermore, we expect losses will continue to increase, as borrowers experience rising loan payments due to the resetting terms of their adjustable-rate loans and principal amortization that occurs after the interest-only period ends for both adjustable-rate and fixed-rate loans.
Although property values have decreased slightly, additional declines are expected. David Wyss, Standard & Poor's chief economist, projects that property values will decline 8% on average between 2006 and 2008, and will bottom out in the first quarter of 2008.
Fewer Refinance Options
While our LEVELS model assumes property value declines of 22% for the 'BBB' and lower rating-category stress environments (with higher property value declines for higher rating-category stress environments), the continued decline in prices will apply additional stress to these transactions by increasing losses on the sale of foreclosed properties, as well as removing or reducing the borrowers' ability to refinance or sell their homes to meet debt obligations.
As lenders have tightened underwriting guidelines, fewer refinance options may be available to these borrowers, especially if their loan-to-value (LTV) and combined LTV (CLTV) ratios have risen in the wake of declining home prices.
The Mortgage Asset Research Institute (MARI) reports that alleged misrepresentations on credit reports were up significantly as a percentage of total submissions received in 2006. MARI, which was recently commissioned by the Mortgage Bankers Assn. (MBA) to conduct a mortgage fraud study, reported that the current findings of fraud were in excess of previous industry highs. Data quality concerning some of the borrower and loan characteristics provided during the rating process has also come under question. Therefore, key risk variables that have historically influenced default patterns, such as the borrower’s credit score under the widely used FICO scoring system, LTV, and ownership status, are proving less predictive.
Quality of Data in Question
It is expected that the ongoing weakness in both national and regional property markets will exacerbate losses with little prospect for improvement in the near term. Also many of these transactions will likely encounter additional credit stress from upcoming interest rate and payment resets.
Data quality is fundamental to our rating analysis. The loan performance associated with the data to date has been anomalous in a way that calls into question the accuracy of some of the initial data provided to us regarding the loan and borrower characteristics. Reports of alleged underwriting fraud tend to grow over time, as suspected fraud incidents are detected upon investigation following a loan default.
In addition, we have modified our approach to reviewing the ratings on senior classes in a transaction in which subordinate classes have been downgraded. Historically, our practice has been to maintain a rating on any class that has passed our stress assumptions and has had at least the same level of outstanding credit enhancement as it had at issuance. In the future there will be a higher degree of correlation between the rating actions on classes located sequentially in the capital structure. A class will have to demonstrate a higher level of relative protection to maintain its rating when the class immediately subordinate to it is being downgraded.
For transactions that close on or after July 10, 2007, we will incorporate several changes to our ratings methodology that will result in greater levels of credit protection for rated transactions. Our cash flow methodology assumptions will include a simultaneous combination of faster voluntary and involuntary (default) prepayments.
Given the level of loosened underwriting at the time of loan origination, misrepresentation, and speculative borrower behavior reported for the 2006 vintage, we will be increasing our review of the capabilities of lenders to minimize the potential and incidence of misrepresentation in their loan production. A lender's fraud-detection capabilities will be a key area of focus for us.
Issuers of the RMBS in question include:
Aames Mortgage Investment TrustABFC TrustACE Securities Corp. Home Equity Loan TrustAegis Asset Backed Securities TrustArgent Securities TrustAsset Backed Securities Corporation Home Equity Loan TrustBear Sterns Asset Backed Securities I TrustBravo Mortgage Asset TrustCarrington Mortgage Loan TrustCitigroup Mortgage Loan TrustCWABS Asset-Backed Certificates TrustEncore Credit Receivables TrustFBR Securitization TrustFieldstone Mortgage Investment TrustFirst Franklin Mortgage Loan TrustFremont Home Loan TrustGE-WMC Mortgage Securities TrustGSAA Home Equity TrustGSAMP TrustHome Equity Asset TrustHome Equity Mortgage Loan Asset-Backed TrustHSI Asset Securitization Corp. TrustIndyMac INDB Mortgage Loan TrustIXIS Real Estate Capital TrustJ.P. Morgan Mortgage Acquisition TrustLehman XS TrustLong Beach Mortgage Loan TrustLuminent Mortgage TrustMASTR Asset Backed Securities TrustMerrill Lynch Mortgage Investors TrustMorgan Stanley Capital I Inc. TrustMorgan Stanley ABS Capital I Inc. TrustMorgan Stanley Home Equity Loan TrustMorgan Stanley IXIS Real Estate Capital TrustNew Century Home Equity Loan TrustNomura Home Equity Loan Inc.NovaStar Mortgage Funding TrustOption One Mortgage Loan TrustOwnit Mortgage Loan TrustPopular ABS Mortgage Pass-Through TrustRAMP TrustRASC TrustSecuritized Asset Backed Receivables LLC TrustSG Mortgage Securities TrustSoundview Home Equity Loan TrustSoundview Home Loan TrustSpecialty Underwriting and Residential Finance TrustStructured Asset Investment Loan TrustStructured Asset Securities Corporation Mortgage Loan TrustStructured Asset Securities Corporation TrustTerwin Mortgage Trust