Servicing and other remaining risks will limit how much the performance of securitized U.S. residential mortgage loans originated during 2005-2008 will benefit from rising home prices, according to analysts.
While the rate of new defaults in 2005-2008 RMBS loan pools will decline as loan-to-values for borrowers improve, Moody’s Investors Service expects losses tied to loan servicing issues will significantly offset the benefits deriving from home equity incentives that motivate borrowers to stay current on their mortgage.
Mortgage servicers “continue to face numerous challenges," says Moody’s VP Peter McNally, despite efforts to clear their pipelines of delinquent loans through
“Long timelines for foreclosure, which will press losses upwards,” indicate they still need to liquidate a high number of loans in serious delinquency, he said.
Analysts list among the default risks of these legacy RMBS issuances rising interest rates that decrease the credit protection from excess spread in a transaction and structural weaknesses that expose some bonds to declining credit enhancement when loan pools shrink.
“Given the complexity of many RMBS structures,” Moody’s Jiwon Park sees opposing factors at play. “Some bonds will benefit from the overall improvement in loan performance, while others will be more affected by the downside risks.”
Servicing issues that could offset the benefits of price improvements include inefficient delinquent loan workouts and cash flow disruptions from upcoming servicing transfers, he said.
For example, “looming writedowns from unrecognized forbearance modification losses” is a significant risk, he said, because about 30% of the loans outstanding backing 2005-2008 vintage subprime RMBS are modified.
Alongside home prices, interest rates are moving up, and higher rates, he explained, “will reduce the credit protection from excess spread in transactions that have modified loans with low fixed rates, but pay out floating rate bond coupons.”
