A rising number of RMBS are now exposed to 'tail risk', Fitch Ratings said in a report released today.
This, the rating agency said, is a growing concern that can negatively impact existing RMBS transactions. Thus, Fitch analysts said that this problem needs to be addressed in new-issue deals, Fitch said.
Existing RMBS, according to analysts, are increasingly being left with outstanding small pools as call-options are not exercised as much as in the past.
Although not a new phenomenon, analysts said that 'tail risk' can result in more volatile collateral performance and higher credit risk.
"Most existing RMBS transactions are not structured to protect against the potential for increased performance volatility as the pool size declines," said Managing Director Grant Bailey.
Because of the said risk, Fitch is raising credit enhancement rating thresholds as well as incorporating rating ceilings on outstanding RMBS backed with a small number of remaining mortgages and that do not have any structural mitigant protecting against tail-risk.
Structural features that lessen tail-risk can include a subordination floor. This is defined as a percentage of the original pool balance that offers a minimum amount of credit support for rated classes throughout the life of the deal.
Other potential structural mitigants can be a feature that converts class principal distribution from pro-rata to sequential if the pool balance drops to less than a pre-determined threshold.
Reflecting the rating agency's more stringent credit enhancement on mortgage loans that have small pools, Fitch placed 1,810 U.S. RMBS classes on Rating Watch Negative.
For deals that do not have enough structural features to protect against tail-risk, Fitch will, for the most part, cap its existing RMBS credit ratings at 'A' for bonds backed by around 100 remaining loans or less.
Fitch will also withdraw ratings on bonds backed by around 50 remaining loans or less.
And, when analyzing new offerings, the rating agency will consider various factors to assess the potential tail risk that bondholders are exposed to.
"Key determinants would include the diversity of the mortgage pool and the presence of any structural features, such as a credit support floor, that could help to mitigate such risk," Fitch Managing Director Rui Pereira said.
