Severity rates for Green Tree manufactured housing ABS are expected to continue their positive trend in 2005, decreasing by 4% to 5%, according to analysts at Lehman Brothers. The declines have been largely due to a stable liquidation timeline, meaning the servicer can re-sell repossessed loans at a consistent rate, and an increase in land-home liquidation percentages. Land-home liquidations allow the servicer to re-sell not only the chattel, but also the real estate, which goes up in value. Green Tree severity rates have declined on an average 7% annually since December 2002. The 2004 average severity rate was 81%, down from 87% the year before.
Lehman analysts anticipate a marginal improvement in valuations as a result of the decrease in severities. The return on current-pay senior tranches could decline as severities decline and more cash is available to pay down and shorten bonds, representing a negative premium. A decline in severities would primarily improve the return on the five-to-seven year and the M1 bonds. A 2% to 3% decline in severities could increase the return on the five-to-seven year bond by 25 to 26 basis points and the M1 by 100 to 200 basis points, according to Lehman's projections. The long-dated cash flows benefit from the fact that, with lower severity rates, the bonds take smaller losses. Lehman recommends taking profits in short dated senior paper and moving out in duration and potentially down in credit in certain seasoned M1 classes, as those securities are expected to benefit from a decline in severity rates over the short term.
The rate of time to liquidation declined markedly until 2004, because Green Tree Servicing chose to liquidate chattel and repo-refi units at a higher rate, focusing less on land-home liquidations.
This contributed greatly to the decline in severity rates on an aggregate level, and the shorter liquidation timeline for all product types has also helped decrease severity rates for all units. Land-home units tend to experience the lowest severity rates of the three types of Green Tree loans at roughly 60% severity. Chattel and repo-refi loans tend to experience 80% to 90% severity, respectively. Lehman expects Green Tree's percentage of land-home liquidations will stay flat, but an increase in that percentage can only further benefit loss severities.
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