By Robert B. Pollsen and Ernestine Warner, Standard & Poor's Ratings Services
The U.S. residential mortgage market has benefited greatly from the unprecedented economic boom and robust housing market of the past five years. As a result, in 2000, Standard & Poor's focused its review process on identifying those residential mortgage-backed securities (RMBS) deserving consideration for an upgrade, which has led to the largest number of upgrades in Standard & Poor's history. The surveillance performed from the beginning of January through mid-December has resulted in 665 ratings changes, consisting of 502 upgrades and 163 downgrades.
Surveillance analyses resulted in ratings changes based on the following factors: credit support, performance, changing credit risks, seasoning, and rating dependency. The vast majority of transactions rated had senior/subordinate shifting interest structures where the higher-rated certificates were supported by the lower-rated, and/or unrated certificates.
For this review, three main collateral types for residential mortgage lending were analyzed: prime, subprime, and home improvement loans. Prime mortgage loans are made to borrowers of pristine credit quality. The subprime category includes subprime mortgage loans made to borrowers of less-than-pristine credit quality, home equity loans, high combined loan-to-value (high CLTV) loans, and home equity lines of credit (HELOCs). And home improvement loans include conventional and FHA-insured Title I loans.
Prime Mortgage Loan Transactions
Transactions backed by prime mortgage loans received the greatest number of ratings upgrades. There were 486 ratings changes in this category, of which 460 were upgrades, and 26 were downgrades. In each case, the ratings changes were a direct result of mortgage pool performance. In total, 472 classes within 233 series were affected.
Residential Funding Mortgage Securities I Inc. and Prudential Home Mortgage Securities Co. Inc. received the most ratings changes, since they were among the issuers with greatest seasoned securitized volume. Generally the upgrades exhibited the following characteristics:
*Credit support percentages that are greater than the original percentages for the new rating levels;
*Low delinquency and loss performance trends;
*Improved pool risk profile;
*Significant principal prepayments;
*Seasoning of at least five years for 30-year mortgages, and three years for 15-year mortgages; and
*Loans that had aged beyond the expected peak period for losses.
All of the 26 downgrades resulted from poor mortgage pool performance. Typically, these ratings were initially below investment grade (that is, BB' or lower), and are more sensitive to defaults because these classes are in the early loss positions. The prime issuers whose public ratings were most affected by the lowered ratings were Saxon Mortgage Securities Corp. and CWMBS Inc. Approximately half of the downgraded classes had a well-established trend of poor mortgage pool performance, and their ratings had been lowered during prior years. The ratings of the remaining classes were lowered for the first time this year, as delinquency and loss performance on the underlying mortgage loans continued to worsen.
Downgrades Outnumbered Upgrades for Subprime
Transactions backed by subprime residential mortgage loans experienced 96 rating changes. Downgrades outnumbered upgrades for this collateral type, with 71 downgrades affecting 43 classes within 35 series. The subordinate class B certificates represented all but one of the downgrades. There were 25 upgrades that affected 18 classes within 16 series. Ratings on seven of these classes were raised twice this year.
Out of 71 downgrades, 36 resulted from rating dependency, where 18 classes were lowered twice in connection with the downgrade of Conseco Finance Corp.'s long-term credit rating. Each certificate has credit support from a limited guarantee provided by Conseco. On April 12, 2000, Standard & Poor's downgraded Conseco to BB-', and shortly after, on May 3, 2000, to B-'. The remaining 35 downgrades were a result of poor performance. Several of these classes had been downgraded prior to 2000.
Strong pool performance resulted in 25 upgrades within transactions seasoned three or more years. The pool factors for most of the transactions had been reduced to less than 50% of the original pool principal balance. Credit enhancement percentages had increased to become greater than the original percentages for the new rating levels. The primary issuer affected was Salomon Brothers Mortgage Securities VII Inc.
Helocs And High CLTV Ratings Changes
Beneficial Home Equity Loan Trust's HELOC transactions received raised ratings on three different series. One class in each series received an upgrade due to sound mortgage pool performance.
Transactions backed by high CLTV collateral received 16 downgrades; the downgrades affected 10 classes within nine transactions. Poor mortgage pool performance was the cause of 10 downgrades, while the remaining six downgrades were attributed to rating dependency. Three dependency-related classes received lowered ratings adjustments twice this year as a result of Conseco's downgrade. These classes also received dependency-related ratings adjustments in 1999. Single ratings adjustments were made to four other classes for the first time. These ratings adjustments were due to poor mortgage pool performance.
Conventional and FHA-insured Title I home improvement transactions received a total of 64 ratings changes, consisting of 50 downgrades and 14 upgrades. In all, 42 classes within 28 series were affected (six of the series received both upgrades and downgrades).
Lowered ratings affected 28 classes within 25 series and were split between performance (six classes within three series) and rating dependency (22 classes within 11 series). Three of the The Money Store Home Improvement Trusts received six downgrades due to poor performance. The lowered ratings were split evenly between mezzanine classes originally rated A' and class B bonds originally rated BBB'. As a direct result of Conseco's downgrades, ratings were lowered twice this year on 22 classes, resulting in 44 rating dependency-related downgrades.
Raised ratings affected a total of 14 classes within nine series of Green Tree conventional or FHA Title I home improvement loan trusts, and all are due to strong performance. Raised ratings on transactions backed by home improvement transactions generally had the following characteristics: credit support percentages that were greater than the original percentages for the new rating levels, good delinquency and loss performance trends, significant principal prepayments, and seasoning of at least four years.
Only 12 Classes Defaulted
There were only 12 classes whose ratings were lowered to D' or default level. Five classes were backed by prime collateral, another six were backed by subprime, and one was backed by high CLTV. The original ratings of classes backed by prime collateral were not higher than BBB', and all were BB' prior to the ratings adjustments this year. The original ratings of classes backed by subprime collateral were not higher than BBB', and one high CLTV class originally rated BBB+' began the year at CCC'.
The defaults were from transactions ranging in age from two to eight years, with the less-seasoned deals concentrated among the subprime collateral. The actual range in seasoning at the time of default for the subprime collateral was two to three years. All but one of the lower-rated classes backed by prime collateral was seasoned five or more years. The high CLTV transactions had been seasoned three years at the time of default.
The unprecedented economic boom in the U.S. has had a positive impact on the residential mortgage market. The current economic prosperity and rising housing prices have led to the largest number of upgrades in Standard & Poor's history. Substantial seasoning had a positive impact on the senior/subordinate shifting interest structure, and was a major contributing factor in the record 502 upgrades. With seasoning of at least five years for the 30-year mortgage loan pools, or three years for the 15-year mortgage loan pools, the expectation for future delinquencies and losses was greatly diminished, as the transactions were now past the peak in their loss curves. In the absence of material losses, significant prepayments contributed to the growth of credit support percentages.
Concurrently, less credit support was necessary to cover the much lower remaining pool balances. Also, as the transactions aged, the amortization of the mortgage loans and the appreciation of the mortgage properties resulted in less losses.
If the current economic trends continue, mortgage pool performance will likely remain strong, and upgrades of existing transactions will be prevalent. However, even during a sound economy, event-risk-driven downgrades may still exist. Also, if the economy slows down substantially and housing prices fall more than anticipated, delinquencies and defaults will increase, and downgrades may become more widespread.