Despite a strengthening U.S. real estate market, residential mortgage-backed securities issued prior to the financial crisis still face risks.
Rising home prices continue to benefit RMBS that were issued between 2005 and 2008. But risks still remain that could impair performance.
Among those risks are rising interest rates, which reduce credit protection from excess spread in transactions that have modified loans with low fixed rates but pay out floating rate bond coupons.
Around 30 percent of loans outstanding from the 2005 to 2008 subprime vintages are modified loans.
That is according to the report, Home Prices Improve, but Downside Credit Risks Remain in Legacy US RMBS, announced Tuesday by Moody’s Investors Service.
In addition, structural weaknesses in some transactions expose their bonds to declining credit enhancement when few loans are left in the pool.
The New York-based ratings agency said that it expects losses tied to loan servicing issues to significantly offset the greater incentives borrower have to maintain their loan payments as they experience home price appreciation.
Among the servicing issues are loss mitigation decisions that produce inefficient workouts, looming write-down’s from unrecognized forbearance modification losses and cash flow disruptions from future servicing transfers.
Moody’s Vice President Peter McNally, who was among the report’s authors, warned that long foreclosure timelines and the need to liquidate many seriously delinquent loans pose challenges to servicers.
A combination of positive and negative factors will lead to upgrades on some RMBS while hurting others.
“Given the complexity of many RMBS structures, some bonds will benefit from the overall improvement in loan performance, while others will be more affected by the downside risks,” Moody’s Analyst Jiwon Park, who was also one of the report’s authors, stated.
But Moody’s did say it expects the rate of new defaults to decline as home prices climb higher because of improving loan-to-value ratios on loans that have been paid as agreed.
