Private-label RMBS can experience a significant increase in losses in the coming months, according to a recent analysis by R&R Consulting.
R&R is a credit rating and valuation firm in New York.
The securities performing as of December 2011 is a universe of roughly $1.42 trillion. R&R estimated that the amount of added losses likely to materialize is $300 billion.
One-third concentrated in ten arranger names such as Countrywide, Morgan Stanley and JPMorgan. About 17,000 tranches, or 34% of the universe analyzed by R&R, might lose up to 83% of their remaining principal.
In addition, R&R projected that approximately $175 billion of losses already incurred on the loans have not yet been allocated to the bonds in the related transactions. Failure to allocate realized loan losses could distort the valuation of related RMBS tranches.
“The light at the end of the tunnel is still a long way off for RMBS,” said Iuliia Palamar, head of ABS research for R&R. “We are now drilling down into the analysis to identify the individual transactions by vintage, servicer and other important issues with respect to these losses.”
In the course of conducting valuations on RMBS, the R&R analytics team discovered widespread, serious, repeated data discrepancies.
Ann Rutledge, a founding principal, asked the team to measure the magnitude of the discrepancy in the RMBS universe.
To do this, R&R subtracted cumulative losses allocated to the tranches from unallocated, expected losses, which is calculated as the sum of defaults, bankruptcies, foreclosures and REOs minus recoveries.
“The results were very disturbing: $175 billion of unallocated current losses and $300 billion of imminent losses,” Rutledge said.
The implication for RMBS bond holders is significant. Subordinated securities in the RMBS with probable future losses ought to be written down by such losses but instead may be continuing to receive interest owed to more senior tranches.
This can also mean that servicers are earning fees against loans that have already been liquidated, which also reduces the amount of cash to pay senior bond holders, according to the research. For example, in one month, servicers can generate $75 million or more in inappropriate fees against the $175 billion in unallocated losses.
Rutledge also noted that R&R has observed a steady increase in amount of limbo losses, raising the prospect that a significant amount of funds are still being misallocated for bond investors.
“The system for MBS is still fundamentally broken,” she said. “All the loose ends need to be identified and knit together into a well-functioning system before investors can feel comfortable investing in RMBS once more.”