Kensington Mortgages announced in its latest investor report that its RMS 15 and 16 U.K. nonconforming RMBS deals had tapped the respective reserve accounts supporting the transactions. Although Fitch Ratings said that it would take no immediate rating action on the RMS reserve draws, the news has added some pressure on nonconforming spreads beyond the credits affected.
The recent credit concerns have caused some widening in nonconforming spreads. Junior tranches have suffered the biggest impact, with triple-B paper widening the most, said analysts at Royal Bank of Scotland. They added that further tiering will likely take hold over the remainder of the year. "The RMS bonds rarely trade, but offer indications yesterday suggested that the senior bonds would trade about 7 to 10 basis points behind solidly performing nonconforming transactions," analysts said. "This widening has dragged out spreads across the nonconforming sector."
The Kensington announcement comes as no surprise. Fitch said that when it affirmed the ratings on the Kensington series of transactions 11 through 16 in March this year, it noted the general increase in the level of delinquencies within a large number of the pools, particularly on the RMS15 and RMS16 deals. In the latest reported quarter, reserves for RMS 15 and 16 were shown to have been tapped for GBP710,000, 4% of total reserve of GBP17.6 million and GBP510,000, 1.9% of the total GBP26.6 million reserve. The quarter's losses totaled GBP1.1 million for RMS 15 and GBP715,017 for RMS 16, but excess spread only reached GBP433,373 for RMS 15 and GBP205,017 for RMS 16, leaving deficits covered by the reserves.
According to Fitch, the RMS15 transaction closed in July 2003, with an original balance of GBP650 million and a required reserve fund of 2.7%. The pool balance has now amortized to GBP352.9 million and the reserve fund now represents 4.8% of issuance. Since origination, Fitch said that the delinquencies continued to increase at a rate well beyond the sector average and above delinquencies for its 2003 vintage peer group.
The 90-plus day arrears level as of May 2005, now stands at 21.24%. As a result of the reserve fund draw, the notes will now continue to pay sequentially after 3Q05 - no reserve fund draw was a condition, which could have otherwise facilitated a pro-rata pay down of the notes in this present situation, said Fitch. The GBP800 million RMS16 closed in September 2003, with a required reserve fund of 3.3%, the pool has now amortized to GBP514.9 million, with the reserve fund representing 5.1% of issuance. RMS16 saw arrears of 90 days plus at 19.94% as of May 2005.
Interest-only detachable coupons linked to the Class A are at a size of 2.35% for both RMS15 and 16. In the latest June investor report, the RMS15 detachable coupons stripped out around GBP1.9 million of the GBP8.5 million available revenue funds, while the RMS16 detachable coupons took GBP2.85 million of GBP11.9 million available revenue funds, said Fitch.
The existence of the detachable coupon was taken into account in the initial rating analysis. This led to a larger reserve fund than would have been the case without a detachable coupon. "If Kensington Mortgage had not used these instruments, GBP1.9 million used for RMS 15's detachable coupons and a staggering GBP2.9 million for RMS 16's would have more than covered the quarter's losses," said RBS analysts.
But the structuring provides protection for senior note holders. The transactions pay sequentially in order of priority, unless the deal meets several tests. They include having a ratio of triple-A rated notes to the sum of Class M and B notes that is less than half the level at closing, 90-plus days arrears below 22.5%, and no amounts outstanding against the reserve fund, liquidity facilities and principal deficiency ledger.
Kensington's woes don't just end with the RMS 15 and 16 series. Analysts at RBS said given the current pool margins and loss vectors, Kensington's RMS 17 looked vulnerable to tap its reserve account over the next successive quarters. "We do not believe that Kensington Mortgages is out of the woods yet, now that its reserves on RMS 15 and 16 have been tapped (and look likely to be tapped at least one more quarter based on arrears performance) and RMS 17 looks likely to be tapped in the quarter ending August, but the losses thus far looked surprisingly small," said analysts at the bank. "The other rating agencies have not yet commented; however, we believe that Kensington Mortgages is actively engaging with all three rating agencies."
Fitch analysts said that they did not expect the trend to continue beyond the levels seen in the RMS 15 and 16 transaction, and did not expect other transactions in the subprime sector to face similar challenges. However, they noted that arrears are increasing across the board in these subprime mortgage deals. All the same, the sector maintains stable performance within a slowing economy and house price inflation.
As for where spreads are headed in the long term, analysts at RBS said that transactions from the perceived better-quality issuers are expected to tighten, drawing in spreads for the poorer quality issuers. Losses still remain below expectations and even transactions reporting severe arrears look relatively harmless. "In virtually all of these transactions, reserve coverage remains strong with low losses and, as transactions pay senior notes off faster than expected, credit support builds faster underneath more senior notes," explained analysts at RBS. "We believe that investors will begin tiering more based upon performance and structure."
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