Higher Rates Could Pose Threat

With interest rates rising and home prices poised to decline, the duration of RMBS transactions is likely to extend and defaults may rise, according to Standard & Poor's.

However, S&P said that the potential rise in defaults and losses should be covered by the availability of more excess interest.

Credit analyst and S&P director Terry Osterweil, who spoke at the rating agency's recent conference in Orlando, Fla., said that the RMBS industry faces several new challenges in a rising rate environment.

S&P developed a "housing volatility index" in 1998 to predict the volatility of house prices across the country.

"Current data are showing a shift toward more volatility in house price changes. This has resulted in an increase in market value declines, and therefore increased severities and loss coverage requirements," Mr. Osterweil said.

In fact, S&P is developing a stress test to measure the impact rising interest rates are likely to have on default and loss rates across the entire structured finance sector.

S&P said that participants in the recent conference also expressed concern about the rise of interest-only loans, which carry no principal payment and no equity buildup outside of home price appreciation.

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