Many segments of U.S. structured finance were forced to play defense to varying degrees during the last few years in light of this past economic recession. Much of 2010 was viewed as a year of 'lessons learned'. But now with the economic recovery slowly underway, we may finally begin to see U.S. structured finance turn the corner towards stability in 2011. Fitch's Rating Outlook for U.S. structured finance is Stable.
The four main structured finance sectors - ABS, CMBS, RMBS and CDOs - have felt the recession's impact to different degrees. The relative performance of those sectors provides clues as to the best practices necessary to limit future performance and rating stability. Fitch believes that the securitization market will employ many of the lessons learned and as a result 2011 will see transactions with improved loan quality from higher credit quality issuers employing less complex structures.
Delinquency and loss metrics are better than they have been in years for U.S. ABS in several asset classes. This has enhanced the already-high degree of rating stability that consumer asset types have exhibited in spite of substantial recessionary headwinds. As a result, the outlook picture for 2011 looks even better for U.S. ABS.
Liquidity is returning to the U.S. CMBS market, though the inventory of specially serviced loans remains high. It should be noted, however, the rate of loans going into special servicing is slowing as special servicers are making more progress with loan workouts. This, with the first signs of rating stability, gives the CMBS sector some good news in 2011.
Property prices are rebounding in many markets for U.S. RMBS, though the huge shadow inventory of distressed and unsold properties continues to put pressure on home values. The latest affidavit issues surrounding judicial foreclosure processes will only cast further a pall on a housing recovery that was slow out of the gate to begin with.
The worst appears to be finally over for U.S. CDOs, which was among the most negatively impacted of the structured finance sectors. Structured finance CDOs with exposure to CMBS may see some marginal downgrades in 2011 due to pressure in the underlying CMBS sector. Bank TruPS CDOs will continue to face increased, albeit slowing, deferrals and defaults, while the outlook for high yield and middle market CDOs is promising heading into 2011.
ABS: Asset Performance Stable for Prime Auto Loans as Ratings Improve to Positive
U.S. ABS showed the most notable resiliency to the recessionary headwinds of 2007-2009, with rating performance remaining largely stable save for minor downgrades to subordinate tranches. With the broader economy now stabilizing and positive rating actions becoming more frequent in certain sectors, the outlook looks generally brighter for U.S. ABS as a whole in 2011.
Fitch projects additional improvement in credit card asset performance indicators such as chargeoffs and defaults, along with a Stable Rating Outlook.
The credit quality of FFELP student loan collateral remains high, which augurs for a Stable Outlook for FFELP student loan ABS in 2011. Conversely, the Outlook for its private counterparts remains Negative.
Declining annualized net losses (ANL) coupled with a strengthening economy and healthy used vehicle values, is expected to pave the way for stable asset performance for U.S. auto loan ABS next year, along with an improved Rating Outlook (to Positive).
CMBS: Property Fundamentals and Ratings Turn the Corner, While Loans Still Lag
Property market fundamentals and CMBS loan performance will begin to diverge in 2011. While commercial real estate fundamentals are likely to enter a period of stabilization, loan performance will remain plagued by the effects of asset-specific tenant rollover and high leverage.
CMBS delinquencies have slowed in recent months as the pace of resolutions, which have averaged roughly $2 billion per month, offset new loan defaults. However, Fitch projects loan delinquencies to continue climbing in 2011. The same holds true for commercial real estate loan collateralized debt obligation (CREL CDO) delinquencies in 2011.
Property market fundamentals have begun to turn the corner. Balance is being restored across property types with respect to supply and demand, largely thanks to a dearth of construction financing dating back to 2007. Market vacancies have also peaked on aggregate in many of the largest markets and rents have bottomed out, paving the way for property market stabilization 2011. It will however, be some time before growth is seen.
While CMBS loans will continue to face pressure in 2011, Fitch expects that past rating actions, coupled with current actions when completed (reflecting poor performance that occurred in 2010), will lead to ratings stability going forward, especially with respect to investment grade CMBS. Fitch's 2011 outlook for U.S. CMBS is stable.
RMBS: Further to Go to Reach Bottom
Following the deep U.S. housing market recession, this year saw the first national year-over-year increase for U.S. home prices in four years. Heading into 2011, however, home prices will come under pressure again as government support programs have expired or been exhausted. The market also still needs to digest a significant amount of distressed inventory with weak demand.
While foreclosure timelines and liquidations have slowed due to loan modification schemes and self-imposed moratoriums, Fitch believes that this inventory ultimately needs to be cleared in order for the market to begin a sustainable recovery. Consequently, Fitch projects an additional 10% national decline.
The sector also faces continued substantial headline risk heading into next year. U.S. residential mortgage servicers' will remain under the spotlight due to operational deficiencies uncovered in recent months. Attorney generals in all 50 states and other federal bodies have launched probes focused on the foreclosure processes employed by large U.S. mortgage servicing companies.
While arrears have begun to stabilize across U.S. RMBS sub-sectors, Fitch remains cautious as to whether this stabilization is sustainable given macro-economic conditions and unemployment, as well as the expectations for a further 10% decline in home prices over the next 12-months. Key factors that will continue to weigh on performance include negative equity for recent vintage collateral, lower loan modification volume, and slightly higher loss severities.
CDOs: Slowly Turning the Corner to Stability
U.S. CDOs saw negative rating actions ebb in 2010 relative to the prior two years due to improving credit trends in the U.S. high yield market and slowing U.S. RMBS negative rating actions. Overall, investment grade rated tranches were relatively stable, while non-investment grade and distressed rated tranches were more susceptible to downward rating pressure. Fitch expects these trends to continue in 2011 to varying degrees depending on the underlying market sector.
The U.S. high yield market is on pace for one of the lowest default rate levels on record this year. This projected drop in defaults also played into a rebound in recoveries, a plus for legacy CLO portfolios. These developments will help support rating stability in the U.S. high yield CDO market sector in 2011.
For the TruPS CDO market, there is ongoing uncertainty regarding a return to stability. Although new bank deferrals have slowed, it is too early to be deemed a trend. Fitch believes that its current criteria captures the credit risk present in TruPS CDOs. Future rating actions will be driven by each transaction's ability to generate sufficient interest proceeds to service its debt especially for the senior-most notes.
Structured Finance CDOs have seen substantial negative rating movement over the last three years as a direct result of the poor performance of RMBS, and they may not be entirely out of the woods yet. The limited number of structured finance CDOs with remaining investment grade ratings may be adversely affected by their exposure to CMBS downgrades.
Kevin Duignan is a group managing director and head of U.S. structured finance for Fitch Ratings.
