The past 15 years have seen total RMBS rating upgrades outpace downgrades by a two to one ratio, and in each of the past 10 years more deals have been upgraded than downgraded, according to an historical study by Moody's Investors Service. The only thing that is likely to put a stop to that trend is a rise in mortgage rates, which so far, unexpectedly, has not happened.
If and when mortgage rates begin to rise appreciably, as has been expected since the Federal Open Market Committee began tightening last year, Moody's expects the pace of RMBS rating upgrades and downgrades to even out. "It's been more of an anomaly these past few years," said Julia Tung, senior analyst with Moody's. If the housing market cools and mortgage rates rise, "there should be a return to a more normal state," she added.
The Moody's study shows that since its first RMBS rating downgrades in 1988, through 1993, 67.2% of downgraded deals were caused by downgrades to third-party credit support providers. From 1993 through this year, less than 1% of RMBS downgrades have been caused by downgrades to credit support providers, with weak collateral performance as the main driver of downgrades. Part of that reduction can be explained by the fact that the importance of third-party support providers reduced significantly during that time.
The study shows that RMBS upgrades were relatively scarce until 1992, but thereafter, strong collateral performance began contributing to large numbers of upgrades in an increasingly favorable housing market. Low interest rates and home price appreciation have combined, especially in the past five years, to create an environment conducive to an increasing amount of loans prepaying out of pools building up credit enhancement.
The same combination of slower home price appreciation and rising interest rates is expected to bring the upgrade-to-downgrade ratio back to earth. In the report, Moody's says it expects those factors to combine to cause pool performance to lose strength, as troubled homeowners will no longer be able to quickly sell their homes and pay off their mortgages. Furthermore, Moody's expects a weaker housing market to increase the lag time between foreclosure and sale of acquired property, reducing recoveries on defaulted loans.
"Downgrades could begin to occur with greater frequency, and upgrades with less frequency, depending on how quickly or how severely the housing market weakens or interest rates climb," according to Moody's.
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