Market players have raised the red flag on U.K. nonconforming RMBS. Recent developments in the market - namely the summer credit crisis and teaser rates set to expire at the end of 2007 and beginning of 2008 - are some of the factors that have left the sector vulnerable to poor performance.
"We are expecting some pain in households as rates rise and, therefore, arrears," said a market observer at Fitch Ratings. "We have downgraded a few so far and expect more downgrades to come."
Analysts at Deutsche Bank have confirmed caution in the U.K. nonconforming RMBS market, reporting that, "highly levered asset markets where refinancing is crucial to borrower payment behavior will of course be most at risk. In this respect, we remain very bearish on the U.K. nonconforming mortgage sector," despite the markets 44% year-on-year growth.
Europe's liquidity crisis and general repricing of risk negatively impacted the U.K. nonconforming RMBS industry, according to the Royal Bank of Scotland. "We have already seen one of the smaller lenders, Victoria Mortgage Funding Ltd., file for administration and the scarcity of funding for the industry has forced virtually all the lenders to adjust their product mix, cutting the highest risk products, and increasing margins to reflect the greater risk aversion among investors," the banks analysts said in a report. Many other U.K. non-conforming mortgage platforms have ceased operations as well.
In light of the recent credit situation, many mortgage lenders have since withdrawn their more aggressive lending models, opting rather to return to more basic lending fundamentals, which may further oust more first-time borrowers out of the housing market. "We believe that given the difficulty that lenders currently face obtaining funding, they are unlikely to be in a position to call transactions reaching optional redemption dates, substantially increasing the extension risk in transactions which are expected to be called in the near future," the RBS analysts said.
Liquidity concerns seem to be spreading into other areas beyond U.K. nonconforming RMBS, in recent weeks reaching the Russian bank lending system, where the central bank intervened to normalize the resulting dislocation in the interbank funding market, the Deutsche Bank analysts said. In addition, housing prices in Ireland registered their first annual decline in more than 11 years during September, suggesting poor performance in the Emerald Isle's nonconforming RMBS sector. Spanish RMBS deals have begun to show a climb in arrears (see Spain story page 20).
However, amid the crumbling, Deutsche Bank analysts said that sectors such as prime German and Dutch RMBS, non-U.K. conduit CMBS, and large loan bank CLOs will likely outperform going forward.
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