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Moody's New Housing Methodology Could Result in Downgrades

DEC 20, 2012 10:25am ET
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 Moody's Investors Service is placing 341 ratings, totaling $2 billion of debt under review for downgrade as a result of its new methodology for stand-alone housing bond programs secured by credit enhanced mortgages.

In total, Moody's rates 687 stand-alone housing bonds, with approximately $5.5 billion of debt outstanding.

The new methodology replaces and consolidates 17 existing methodologies for credits that are stand-alone, meaning they're financed under a single stand-alone indenture, and that are secured by credit-enhanced mortgages.

"All of our bonds that have those characteristics are now covered by this one methodology, so it sort of puts everything in once place," said Florence Zeman, associate managing director at Moody's and one of the co-authors of the new rating methodology.

Credit enhancements for the covered bonds include Ginnie Mae, Fannie Mae, or Freddie Mac mortgage-backed securities, Federal Housing Administration standard-risk and risk-sharing mortgage insurance, and the State of New York Mortgage Agency project pool insurance.

The new methodology, which went into effect last week, incorporates changes that were initially introduced in a request for comment in March.

"Most notably, we believed that some of these credits are vulnerable to administrative errors and, as such, should not be rated triple-A," Zeman said.

Certain programs have been financially weakened because a participant failed to fully carry out duties related to the bond financing documents. The new methodology will cap programs vulnerable to such risks at Aa1.

Most of the affected bond programs—a total of 328—have been placed under review due to this change.

The methodology also incorporates revised assumptions for reinvestment rates, due to continued low interest rates. In 2009, Moody's changed its reinvestment rate assumptions to 0% based on an expectation that rates would begin to rise. As rates have stayed low, the approach has been revised to incorporate a longer low-rate environment period.

As a result of this new approach, the other 13 ratings of bond programs are being reviewed.

Bond ratings under review could either stay the same or they could be lowered depending on an assessment of the four key credit factors under the new methodology.

The first factor is mortgage enhancement, which is measured by the enhancement provider's financial strength and terms.

"The enhancement provider's financial strength, as indicated by its credit rating, serves as the ceiling for the bonds' highest eligible rating," the new methodology report said. "Changes in the enhancement provider's rating will usually result in a similar rating change to the bonds barring other unusual credit considerations that alter the rating."

The second factor is legal framework and is measured by the security pledge and collateral, flow of funds, mortgage repayments, bond redemptions and reserves.

The third factor is cash flow projection performance, which looks at monthly mortgage payments, prepayments, investment income and trust accounts.

"The primary purpose of these projections is to measure a program's ability to meet its debt service obligations," the report said.

The fourth factor that Moody's looks at is investments, which the agency says could be critical to a program's overall cash flow adequacy.

Moody's expects that most reviews will conclude in a one-notch downgrade to Aa1 from Aaa. Zeman said the typical review period lasts around 90 days.

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