Fitch Ratings published an exposure draft introducing its new rating model that determines losses on newly originated residential mortgages.
For the next 45 days, Fitch is seeking market comments on its new model framework.
The rating agency's new model framework has various updates and improvements, such as the application of a proprietary sustainable home price model that measures a property’s effective or sustainable value.
Fitch compares the sustainable value to the actual price and is able to take a forward look at the potential for negative equity that has strongly influenced borrower default.
"Fitch's criteria has always recognized the importance of equity as a driver of borrower default behavior,’ said Rui Pereira, managing director and head of U.S. RMBS. "Fitch’s new approach now measures how much of that equity is real versus how much was created merely as a result of a price bubble."
The updated framework also incorporates data from the recent recession and unprecedented national home price decline.
In developing its default regression model, the rating agency considered cumulative default expectations on older prime vintages while also looking at cumulative default view on ‘peak’ vintages originated before the recent crisis.
Fitch’s new model is also countercyclical and based on home price movements where credit enhancement rises as risk enters the system and decreases when risk is neutralizing.
Additionally, rating levels can be more easily associated with the different economic stresses and home price decline scenarios in Fitch’s new approach, which will offer an increased level of transparency.
Fitch intends to apply the new criteria to pools of newly originated, prime mortgage collateral and expects that credit enhancement levels will be significantly higher versus pre-crisis levels specifically for pools with layered risk attributes.
As such, Fitch expects that if crisis-level home price declines are experienced in the future, rating stability would be substantially greater.
New prime mortgage production has so far been characterized by lower combined LTV ratios, more complete documentation and higher credit quality borrowers, according to Pereira.
Fitch’s new modeling framework can more effectively differentiate risk across the prime sector and recognizes the strength of this higher quality collateral versus the loans advertised as prime during 2005-2007.