New York, January 27, 2010 -- Moody's Investors Service has revised its loss projections for U.S.
Option ARM residential mortgage backed securities (RMBS) issued from 2005
through 2007. On average, Moody's is now projecting cumulative
losses of 20% for 2005 securitizations, 41% for 2006
securitizations and 51% for 2007 securitizations, reported
as a percentage of original balance. As a result of the revision,
Moody's has now placed 2,553 tranches of Option ARM RMBS with an
original balance of $332 billion and current outstanding balance
of $196 billion, on review for possible downgrade.
Moody's has already taken widespread rating actions on deals backed by
Option ARM collateral from the 2005-2007 vintages in the first
quarter of 2009. The updated loss projections will have the greatest
impact on senior securities issued in 2005.
On October 29, 2009, Moody's announced that it would update
certain assumptions underlying loss projections for each of the major
RMBS sectors. The continued deterioration in performance of Option
ARM pools in conjunction with macroeconomic conditions that remain under
duress prompted today's announcement. Since the first quarter of
2009, when Moody's last announced a revision to its Option
ARM loss projections, serious delinquencies (loans that are 60 or
more days delinquent, including loans in foreclosure and homes that
are held for sale) on Option ARM mortgage pools backing 2005 to 2007 securitizations
have increased markedly. Since March 2009, serious delinquencies
for the 2005, 2006 and 2007 vintages have increased to 40.4%
from 33.3%, 47.3% from 38.6%
and 41.3% from 30.4% respectively (reported
as a percentage of outstanding pool balance). In the meantime,
cumulative losses realized on the pools have more than doubled to 3.2%
from 1.4%, 7.6%% from 2.9%
and 6.6% from 1.8% for the 2005, 2006
and 2007 vintages respectively.
Even though the Case-Shiller index in recent months had reported
very modest home price gains, the most recent November index report
of a decline underscores Moody's belief that the overhang of impending
foreclosures will negatively impact home prices. Moody's Economy.com
(MEDC) expects home prices to fall by an additional 11% to reach
a peak-to-trough decline of approximately 37%.
Over 70% of Option ARM loans were made to borrowers in California,
Florida, Arizona and Nevada, states that have suffered price
declines of close to 50% from their peaks. As a result,
the estimated average loan-to-home-value ratio of
Option ARM borrowers currently stands at 144%, in comparison
to 132% for Subprime borrowers.
Adding to borrowers' financial pressure, unemployment is now projected
to peak at around 10.5%. Both measures are expected
to reach their peaks in the second half of 2010, after which recovery
is expected to be slow.
Estimation of Losses
To estimate losses, Moody's first projected the growth in delinquencies
through the second half of 2010, based on recent performance and
collateral composition. The increase in new delinquency levels
beyond 2010 is expected to decline with improving economic and housing
conditions. To estimate delinquencies beyond 2010, Moody's
applied a reduction to the delinquency growth rate of 20% for 2011,
35% for 2012 and 45% for 2013 and beyond. This deceleration
reflects home price and unemployment projections by MEDC for years beyond
However, in addition to the baseline delinquency projections,
Moody's incorporated a higher growth in delinquencies due to the
payment shock that some borrowers will experience when their payments
recast from an "option" payment, to one that is fully-amortizing.
The incremental growth in delinquencies from payment shock is calculated
on a pool level depending on the volume of loans "recasting"
and the corresponding payment increase.
Moody's estimated that of the contractually current or 30-day delinquent
loans 17%, 25% and 25% will become seriously
delinquent by the second half of 2010, for the 2005, 2006
and 2007 vintages, respectively.
To calculate the default rate on the projected delinquencies, Moody's
assumed an average roll rate (probability of transition from delinquency
into default) of 97%. The loss on the loan upon default
(severity of loss) is expected to be around 70% on average.
Given the very high level of negative equity and the already low monthly
payments that the borrowers are making, HAMP, in its current
form, will continue to remain ineffective in curbing Option ARM
We expect principal forgiveness as a modification strategy to become more
popular in the future. The updated loss estimates incorporate a
small benefit to projected losses across vintages to reflect this view.
However, we believe it is unlikely to reach a level where it could
significantly reduce losses.
Moody's will release a special report in the coming weeks that will detail
its methodology for determining revised loss projections for Option ARM
transactions issued from 2005 to 2007.
To assess the rating implications of the updated loss levels on Option
ARM RMBS, Moody's will analyze each transaction through a variety
of scenarios in the Structured Finance Workstation (SFW), the cash
flow engine provided by Moody's Wall Street Analytics. The scenarios
incorporate ninety-six different combinations of loss levels,
default timing (CDR) and prepayment (CPR) curves.
On senior securities, the extent of rating actions due to the revised
loss projections will vary by vintage. Currently, over 25%
of the senior securities issued in 2005 maintain investment grade ratings.
Moody's anticipates a majority of these ratings to migrate to B/Caa rating
levels. However, about 95% of the senior securities
issued in 2006 and 2007 are already rated below investment grade and 75%
are rated Caa or lower. Consequently, the ratings migration
for the 2006 and 2007 vintages is expected to be smaller. In general,
bonds that have a short estimated life or are adequately supported by
other senior securities will likely be confirmed or see smaller rating
transitions. The majority of rated subordinated tranches from 2005
to 2007 vintages have already been downgraded to impairment ratings.
Moody's rates securities B2 or higher if they are likely to be paid off
under an expected scenario. If a security is likely to take a loss
under an expected scenario, it will typically be rated B3 or lower.
Securities with expected recoveries of 65% to 95% are rated
in the Caa range. Securities with expected recoveries of 35%
to 65% are rated Ca, while securities with expected recoveries
below 35% are rated C.
Other methodologies and factors that may have been considered in the process
of rating this issue can also be found at www.moodys.com
in the Rating Methodologies subdirectory.
Further information on Moody's analysis of this transaction is available
on www.moodys.com. In addition, Moody's publishes
a weekly summary of structured finance credit, ratings and methodologies,
available to all registered users of our website, at www.moodys.com/SFQuickCheck.
A list of the review actions associated with this announcement may be
Senior Vice President
Structured Finance Group
Moody's Investors Service
Moody's updates loss projections for US Option Arm RMBS issued in 2005-2007
Structured Finance Group
Moody's Investors Service