Scratch & Dent RMBS Issuance Up

These non-standard RMBS deals experienced increased issuance in 2002. This causes increased risk and signals the need for alternative methods for assessing default frequency and severity, the report said.

“We expect steady continued issuance as issuers continue to access the capital markets, with competition being expected to increase as the new market entrants compete with established market players,” said vice president Christine Lachnicht, co-author of the report.

While Moody’s report focused mainly on reperforming loans, it analyzed the impact of all four types. It also defined how it rates these RMBS transactions.

Scratch-and-dent loans, while current, are outside an originator’s program guidelines in some way and therefore ineligible for securitization. The four major categories of non-compliance that lead to a scratch-and-dent label are misassigned credit grade, poor appraisal quality, consumer law compliance issues, and missing loan documentation, Lachnicht said.

Reperforming loans have suffered a serious 90-day or more delinquency in the past, but are back in shape and have demonstrated payment ability once again.

Non-performing loans are seriously delinquent, and the expected outcome for them is liquidation.

The term “sub-performing” is given to loans that also are seriously delinquent, but it’s unclear whether or not they will spring to life and become re-performing, or default further and become non-performing.

These kind of loans have gained ground because over the past year or so, unemployment has gone from 4% to 6%, and consumers are having a hard time making payments, said Michael Stock, director in Standard & Poor’s (S&P) residential group.

“Also, the subprime market is becoming more seasoned,” he said.

Although they’ve experienced performance issues, scratch-and-dent loans usually are performing and haven’t been delinquent, Lachnicht said. Because of this, their credit enhancement levels, with appropriate adjustments for their beat-up nature, are similar to non-scratch-and-dent pools, Moody’s reported.

Carol Fabor, senior director in Fitch Ratings’ residential mortgage group, said Fitch has seen only a small increase in RMBS backed by scratch-and-dents, but nothing significant.

“Volume increased across the board in 2002,” and it’s not surprising to see an increase in scratch-and-dent loans during such a high volume year, she said. Fabor added that she expects issuance of RMBS backed by scratch-and-dent loans to increase a little in 2003, but not a large amount.

Vince Barberio, also a senior director in Fitch’s residential group, said scratch-and-dent loans have become accepted and even quite generic in the marketplace, which also contributed to their increased issuance in 2002.

S&P recently announced that it expects robust issuance of RMBS in general in 2003, although not as robust as the record-breaking issuance of 2002. Nationally stable home prices and low interest rates will continue to influence high volume, S&P reported.