The rate of improvement for U.S. sub-prime residential mortgage-backed securities (RMBS) performance is diminishing, according to Fitch Ratings in a new report. The rate at which sub-prime borrowers become delinquent has been improving notably since 2009. Recently, however, Fitch has observed that the improvement has tempered for loans originated from 2005-2007, while earlier vintage loans have shown little to no improvement.
The slowdown in performance can be attributed in part to the changing composition of the collateral, which is leading to adverse selection. Fitch also found that falling home prices are contributing to weaker sub-prime performance. Home prices declined four percent nationally in 2011, with Fitch projecting a further five percent to 10 percent decline to come.
The report also points to historically high loss severities and relatively thin remaining credit enhancement as drivers of Fitch's ratings on sub-prime classes. Fitch sites high loan-to-value (LTV) ratios, relatively small loan balances, and extending liquidation timelines as causes of elevated loss severities on liquidated loans (currently 77 percent). Senior RMBS classes have lost credit enhancement through a combination of high collateral losses and the redirection of principal toward subordinate classes, according to Fitch.
Fitch has revised its sub-prime expected loss assumptions to reflect recent collateral trends, and conducted a review of its outstanding rated transactions.