Amherst Securities Group (ASG) yesterday released a detailed report that examines recent trends in modification activity in non-agencies. 

Analysts looked specifically at two trends. These are the increased share of principal reduction modifications and the higher share of second and subsequent modifications.

In the report, they showed that principal reductions cause higher modification success rates versus other modification types, even controlling for pay relief. They also demonstrated that second and subsequent modifications have higher redefault rates compared with first modifications.

Analysts also focus on the variations in modification activity and modification success rates in subprime servicers.

They said that most non-agency mortgage market players are not surprised that modification
activity is starting to lessen. This trend actually makes sense given that servicers have gone through most of the universe of delinquent loans and completed the modifications they are required to implement.

Analysts looked deeper at modification activity, concentrating mostly on the subprime arena. There had been more than 70% private-label modifications conducted on subprime securities, they said.

They also zeroed in on changes in modification types and their success rates. Most buyers are aware of the growing significance of principal reductions and analysts confirmed that trend, emphasizing success rates by modification type, and the differences in servicers.

On the flip side, they said that many investors are not aware of the increasing importance of second and subsequent modifications. ASG analysts also looked at these with a mind to modification success as well as variations in mod type in servicers.

Generally, they found a number of interesting results, they said. These are that principal reductions have become a larger overall share of modification activity. But, there is a big difference across servicers.

Controlling for payment relief, analysts found out that principal reduction modifications are more effective compared to either rate modifications or capitalization modifications. These
differences by modification type are bigger for modifications on prime/Alt-A/option ARM loans versus subprime loans.

The second modifications comprise 30% of all recent modifications, and 42% of all recent subprime modifications, which have reflected considerable differences in servicers in terms of second modifications. Most second mods are  because of a weak first modification.

Second modifications also have much higher re-default rates versus the first mods, they reported.  This is even controlling for modification type, pay relief and months in delinquency at modification, ASG analysts said.

To summarize, the report showed that  the number of modifications is dipping, the number
of principal modifications the number of second modifications are increasing.

The report showed that there is a huge difference across subprime servicers, both in modification type and in the amount of first versus subsequent modifications. When lookin at bonds, investors often run similar scenarios across servicers. However, bond cash flows, specifically the cash flows on time-tranched bonds, can be very sensitive to timing.

This is why it is important to look at future modification behavior of the deal’s servicers. For servicing firms that are performing a significant amount of principal mods, buyers should understand what happens to the security if losses happen earlier, ASG analysts said.

Additionally, many servicers are ramping up their principal modification efforts. These changes in behavior must be factored in.

For servicers performing many second modifications, investors might want to build in higher modification re-default rate and assume more near-term recaptures of previously advanced delinquent principal and interest payments to the trust, ASG analysts suggested This lowers the near-term cash flows to the trust.

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