Classes C, D and E under the Provide GEM RMBS structure were downgraded last week by both Fitch Ratings and Moody's Investor Service, echoing investor concerns over the deteriorating credit quality in German residential mortgage pools.

"This was the first performance-related downgrade of a European RMBS in recent history, and was a direct result of an increase in delinquencies over recent months," said one analyst at BNP Paribas.

The German RMBS market in general has suffered the effects of a weakening German economy. Industry sources indicated that the economy has seen a sharp rise in unemployment since 2000 and the German housing market has not picked up either. "Against such a background, it's natural for investors to expect and be concerned with deteriorating credit quality in German residential mortgages," said one analyst at Merrill Lynch. "The higher systematic unemployment and more serious housing depression in the Eastern part of Germany lead most investors to expect more negative performance in RMBS pools with higher concentration to East Germany."

The Provide GEMS transaction came to the market a year ago and is already experiencing losses that have reached 3.23% of the portfolio. The current level of delinquencies and credit events exceed initial expectations despite the fact that there were concessions for higher-than-average delinquencies due to the quality of the portfolio, which resulted in higher credit enhancement at closing.

Factors leading to

negative action

The transaction was originated and serviced by Rheinhyp, the former mortgage subsidiary of Commerzbank that in August last year was merged together with the mortgage subsidiaries of Dresdner Bank and Deutsche Bank to form Eurohypo. Eurohypo now services transactions from all three banks. Industry sources indicated that this disruption in servicing might have also affected pool performance.

The Provide GEMS transaction includes a high proportion of East German loans and, unlike other German RMBS deals, the structure allows for previously delinquent loans to be included in the reference pool. The biggest problem in the deal is tied to difficulties in combining systems from the recent merger of Rheinhyp. "The rise in delinquency was originally attributed to the transfer of loan data to the new servicer, but it's now a year since the merger and delinquencies are still not in line with other deals," explained the analyst at BNP.

Fitch's recent appraisal of the German RMBS market prompted the rating agency to call for greater transparency from German RMBS issuers that would report more accurate information to investors. Fitch also suggested that the market could benefit from the servicer ratings present in the Italian and U.K. markets. But for the most part German RMBS structures have performed well. Along with the downgrade last week, Fitch also upgraded five and affirmed 88 tranches of German RMBS transactions.

"Against such a background, it's natural for investors to expect and be concerned with deteriorating credit quality in German residential mortgages."

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