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18 Mar 2010
New York, March 18, 2010 -- Moody's Investors Service has revised its loss projections for 2005-2007
second lien U.S. residential mortgage backed securities
(RMBS). Moody's expects cumulative losses to average approximately
25-55% of outstanding balance for non-subprime closed-end
second (CES) pools, 70-85% for subprime CES pools,
and 40-50% for HELOC pools. These updated numbers
represent more than a 50% increase for non-subprime CES,
and nearly a 20% relative increase for subprime CES and HELOC pools.
Second lien pools issued prior to 2005 are expected to realize lower cumulative
loss levels as compared to the recent vintages, but are still experiencing
rising loss rates and are therefore also subject to increased loss expectations.
As a result of the increasing loss expectations, Moody's placed
948 tranches of second lien RMBS with an original balance of $113
billion and an outstanding balance of $35 billion on review for
possible downgrade. The review action includes all vintages of
second lien RMBS.
Second lien mortgage pools have experienced elevated loss rates during
the past few years as a result of the sharp decline in home values.
The most important predictor of mortgage default in the past several years
has been the degree to which borrowers have negative equity in their homes.
Borrowers with second liens, particularly those originated in more
recent years, are almost universally in a negative equity position;
most had combined loan to value ratios approaching 100% at origination
and home prices have already dropped by nearly 30% since.
In addition, since defaulting on a second lien does not typically
result in foreclosure, borrowers might choose to default on their
second lien loan in favor of making payments on their first lien loan
in order to remain in their home. All of these factors contribute
to a very high borrower propensity to default on second lien loans.
Subprime CES annual loss rates, measured as total annual losses
against the pool balance at the start of the related year, averaged
38% over the past year, recently dropping to 37% from
their high of 40% about 6 months ago. Non-subprime
CES and HELOC average annual loss rates were slower to take off,
but in the past year have reached 14%, though HELOCs have
shown signs of stabilizing at these levels. Non-subprime
CES loss rates are still on the rise, having increased from 5%
to 14% over the course of the past year. This trend is tracking
the increasing delinquencies in the prime-first lien sector,
where delinquencies have risen from 3% to 9% in the past
Going forward, we expect continued severe pressure on second lien
borrowers, as the overhang of impending foreclosures will impact
home prices negatively in the coming months. Moody's Economy.com
(MEDC) expects home prices to fall by an additional 7%, reaching
a peak-to-trough decline of approximately 34%.
Adding to borrowers' financial pressure, unemployment is now projected
to peak at 10.3%. 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 established baseline annual default
and prepayment rates, which correspond to current loan performance.
The baseline default rates were based on a combination of recent default
rates and the current proportion of delinquent loans, and the baseline
prepayment rates were based on recent voluntary prepayment rates.
These rates represent total annual defaults or prepayments against a pool's
balance at the beginning of the related year.
Moody's developed a forecast of future default and prepayment rates
based on expected trends for each of the second lien sectors. Default
rates on subprime CES are expected to remain fairly level for the coming
year, while default rates for HELOC and non-subprime CES
pools are expected to increase over the near-term. Default
rates beyond the coming year are expected to decline with improving economic
and housing conditions.
To estimate defaults on subprime CES pools, Moody's held the
baseline default rate constant for one year, and then applied a
reduction to the baseline rate of 15% for the second year,
50% for the third year and thereafter to reflect the projected
improving economic environment. To estimate defaults on non-subprime
CES, Moody's applied an increase of 40% to the baseline
default rate for one year before applying a reduction of 10% to
the baseline for the second year, 45% for the third year,
and 60% for years 4 and beyond. For HELOC pools, Moody's
applied an increase of 10% to the baseline default rate for one
year, and then applied a reduction of 20% for the second
year, 60% for the third year, and 70% for years
4 and after. In each asset category, prepayment rates were
held at today's rates in the low single-digits for the lives
of the pools, and no recoveries were expected for defaulted loans.
Moody's will release a special report in the coming weeks that will detail
its methodology for determining revised loss projections for second lien
To assess the rating implications of the updated loss levels on second
lien RMBS, Moody's will compare updated loss projections to available
credit enhancement in the form of subordination, excess spread and
The announced review impacts all securities within the second lien U.S.
RMBS sector currently rated Ca and above. The anticipated actions
will vary, and certain bonds placed on review may have their rating
confirmed to the extent credit support and/or payment priority offer sufficient
protection against updated loss projections to maintain their current
ratings. Moody's expects that upon conclusion of this review,
nearly all outstanding second lien securities issued in 2005 through 2007
will be rated B or lower, although rating transitions for most of
these bonds will be muted since over 82% are already at these rating
levels. Ratings on earlier vintage bonds are also expected to see
substantial downgrades but will maintain generally higher ratings relative
to the 2005 through 2007 vintages.
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. Moody's also 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
Amelia (Amy) Tobey
VP - Senior Credit Officer
Structured Finance Group
Moody's Investors Service
Moody's updates loss projections for US second lien RMBS
Asst Vice President - Analyst
Structured Finance Group
Moody's Investors Service
No Related Data.
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