Moody's Revises Hybrid, ARM Analysis

Moody's Investors Service is refining its loss coverage methodology for subprime hybrid adjustable-rate mortgages

The rating agency said it would apply this revised methodology to subprime securitization deals closing on or after April 15.

The changes are designed "to better account for the observed range in product features utilized in the marketplace, including differences in the interest rate caps and the degree of start rate discount embedded in the loan rate structure," Moody's said.

The rating agency is changing its methodology because its analysis of mortgage pools shows "that variations in these features, particularly under a rising interest rate environment, result in a substantially different level of payment shock to the borrowers, and thus varying mortgage loan performance expectations."

The rating agency said its loss coverage requirements for hybrid ARM products, relative to fixed-rate mortgage products, "already incorporate an increased frequency of default expectation due to payment shock associated with adjustable-rate products.

"A benchmark hybrid ARM pool with an initial cap of 2%, periodic cap of 1% and a start rate 100 [basis points] below the fully indexed rate is used when assessing the incremental credit risk of a hybrid ARM pool," Moody's said.

"Loans with deeper teasers and/or higher initial or periodic rate caps carry greater risk. Moody's adjusts the loss coverage requirement by up to 20% for mortgage pool features resulting in different levels of payment shock relative to the benchmark pool."

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