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DBRS: Most RMBS Downgrades Linked to Second-Lien Collateral
By James Comtois
Most downgrades on residential mortgage-backed securities are linked to transactions backed by second-lien collateral, according to Toronto-based DBRS. As a result, many mortgage servicers are eager to charge off the defaulted second-lien loans before or during foreclosure.
DBRS is a full-service rating agency that provides credit ratings on issuers of commercial paper, bonds, long- and short-term debt, and preferred shares, as well as asset-backed securities. DBRS also offers industry analysis, rating reports and ratings indices for issuers and investors.
According to its recent U.S. Structured Finance Newsletter, DBRS has rated 414 U.S. RMBS transactions to date and has taken rating action on 218 classes -- 80 downgrades, 83 upgrades and 55 under review with negative implications -- across 84 RMBS transactions.
Approximately 75% of the downgrades were related to transactions backed by second-lien collateral. The downgrades in the second-lien subsector are a function of higher actual losses vs. expected losses as well as a more front-loaded loss distribution.
The highly leveraged second-lien borrower is likely to have minimal or negative equity in their property given the current flat to declining home price appreciation environment that is occurring in many areas.
Therefore, these borrowers have limited options in terms of either selling the property at a price that, after costs, will cover the outstanding debt on the property or to refinance their existing mortgage. Consequently, mortgage servicers are quickly charging off the defaulted second-lien loans prior to or during the foreclosure process.
When evaluating the credit status of seasoned transactions, DBRS utilizes various credit metrics. These metrics are also compared across transactions to assess relative performance within a subsector.
One key metric is the Delinquency Coverage Ratio 1, which captures the adequacy of transaction excess spread and overcollateralization relative to anticipated losses as estimated from the from the current 90-plus delinquency pipeline. The DCR ratio, which is provided at a class and pool level, can quickly identify transactions that are vulnerable in the near term to writedowns and deterioration of credit enhancement.
For example, the average pool level DCR for the DBRS downgraded second lien transactions is 0.96. When the ratio is less than one, the possibility of subordinate note writedowns increases as excess spread and OC may not cover futures losses realized from the current delinquency pipeline.
In May 2007, DBRS launched a new RMBS surveillance webpage that features a monthly RMBS Performance Analytics Report for all DBRS-rated U.S. RMBS public transactions. The RMBS PARs are intended to provide investors with standardized summary performance data and credit metrics. The reports are available at www.dbrs.com/par.
For the second half of 2007, DBRS expects to see a further deterioration in performance of the 2005 and 2006 vintages, especially for subprime and second-lien collateral. These subsectors remain especially vulnerable to home price appreciation trends and interest rates. DBRS will continue to take a proactive approach to closely monitor the performance of DBRS rated transactions, particularly in the current stressful environment.
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