RMBS Report Card

This year will be the second year of declining overall issuance of residential mortgage-backed securities, Moody’s Investors Service said in an RMBS market annual review and outlook report.

During 2006, the largest issuance volume decline — 26 percent to $130 billion — occurred in the jumbo sector, according to the announcement. Subprime issuance edged down by 2 percent to $526 billion, and the only sector with growth was Alternative-A, up 6 percent to approximately $449 billion.

The ratings agency noted that although the average median price for existing and new homes is declining, “housing affordability remains relatively low, driving some borrowers to seek so-called ‘affordability’ mortgage loan products,” such as interest-only, 40-year, and payment option adjustable-rate loans.

Although the collateral performance of RMBS has been strong in recent years, mortgage pools issued in recent quarters have exhibited some deteriorating performance trends relative to older vintages. One of these trends is the rising proportion of early payment defaults leading to foreclosure in recently originated mortgages, Moody’s noted.

In the second quarter 2006, over 1.35 percent of underlying collateral was reported in foreclosure, real estate owned or had already realized a loss as of the transactions’ sixth month of seasoning, significantly increasing from the first quarter a year earlier when about 0.40 percent of collateral experienced the above.

While the growing popularity of affordability products contributed to the growth in Alt-A issuance and somewhat offset the decline in the subprime sector, the 2006 vintages of these two sectors particularly saw a significant increase in early payment defaults when compared to other recent vintages, Moody’s said.

Deterioration was most pronounced in subprime pools — the proportion of six-month foreclosure, REO and realized losses more than tripled to 2.59 percent in the second quarter last year from the first quarter in the previous year, according to the report. Additionally, beyond loans in foreclosure and REO, the delinquency pipeline is significant may signal that performance may be an ongoing concern beyond early defaults, according to the report.

While early defaults on Alt-A collateral were stable from 2002 to mid-2005, they sharply increased for transactions issued in the first part of last year. In the second quarter last year, early foreclosure, REO and loss rates represented 0.46 percent of total Alt-A volume, compared to under 0.15 percent of Alt-A loans securitized in the fourth quarter 2005. Additionally, 10 out of 268 Alt-A securitizations in last year’s first quarter realized at least one-dollar of loss within six months of deal closing, compared to only 11 out of 1,200 Alt-A pools closed from 2002 to 2004 that incurred any losses within that same time frame.

“As we have frequently commented on in recent years, originators of subprime loans have loosened underwriting guidelines and materially increased the layering of risk,” Moody’s said in the report, adding that loans without full documentation, to first-time and “80-20” borrowers, and those backed by investor properties have all become materially more prevalent in the transactions it has rated.

Moody’s noted the fallout of some originators last year due to liquidity pressure from early payment default loan buy-back obligations, and said that it expects such pressure to continue this year amid stiffer competition as origination volumes fall, and even though many originators plan to tighten their underwriting guidelines to help moderate further performance deterioration in the future.

“Issuers are examining whether various degrees of underwriting or broker misrepresentation might be causing increases in early defaults,” Moody’s said. “However, there is currently limited data to confirm this as a widespread phenomenon.”

Preliminary data suggest that a majority of early defaults have been associated with purchase, rather than refinance transactions, which indicates that declines in home price appreciation nationwide have been a contributor, Moody’s said. The lack of house appreciation seems to have a greater impact on investment-related borrowers, who may account for a significant proportion of defaulting purchase loans, although the prevalence may be substantially understated because owner-occupancy data may not be reliable.

Moody’s said it is also analyzing whether some early defaults have resulted from obligors who were delinquent as of closing.