Standard and Poor’s: Subprime RMBS Downgrades Surge in 2006

A recent report summarizing the performance of residential mortgage-backed securities in the United States underscores emerging problems in housing markets across the nation, with subprime RMBS downgrades swamping upgrades during 2006 and recent loan vintages performing the worst in nearly a decade.

According to Standard & Poor’s, the U.S. RMBS market saw only a slight drop in volume (2.76 percent) during 2006, with an estimated $1.1 trillion securitized for the year. Subprime securitization volume was estimated at $525 billion for the year.

The number of downgrades in subprime RMBS deals during 2006, however, more than doubled the number of upgrades — a trend the agency said it expects to worsen during 2007.

2006 saw 104 subprime upgrades and 229 subprime downgrades, Standard & Poor’s said, compared with 239 upgrades and 56 downgrades during 2005. Leading the way with subrpime RMBS deals that were downgraded during the year was Morgan Stanley Dean Witter (30), CSFB (26), Long Beach Mortgage (21), and CDC Mortgage Capital (18), the rating agency reported.

In addition to deteriorating subprime RMBS performance, the rating agency also said that performance in scratch-and-dent securitizations also declined during 2006, with 23 upgrades and 49 downgrades in 2006, compared with 21 upgrades and nine downgrades in 2005. Most of the downgrades were from private ratings, the agency said.

While troubles emerged in subprime credit, not all sectors displayed weaknesses in 2006. Ratings on prime jumbo and Alt-A collateral remained relatively stable from prior years, suggesting that so far the downturn in the U.S. mortgage market has been largely limited to subprime credit. Tightening upgrade/downgrade ratios for prime jumbo collateral, however, suggest that some prime borrowers are beginning to have problems with their mortgage obligations.

Standard & Poor’s outlook for 2007 is decidedly mixed. “U.S. RMBS’ performance in 2007 will depend on the state of the global economy, the unemployment picture, and the U.S. housing market’s performance,” the agency said in its report. “One of the more critical areas to watch this year will be U.S. subprime mortgages.”

The agency said downgrades in subprime collateral represented 1.53 percent of outstanding subprime ratings in 2006 versus 0.54 percent in 2005, and said it expects this pattern to continue in 2007. The company said it expects much of the rating activity will remain connected with transactions issued from 2001-2004, citing step-down targets in these vintages that are driving losses that exceed spread and overcollateralization amounts.

Standard & Poor’s also cited concern regarding all credit classes surrounding the 2006 vintage, zeroing in on stated income loans. “Given the backdrop of slowing home price appreciation and minor home price declines, these loans have become the poster children for poor lending decisions,” the agency said. “In addition, they have caused an acceleration of early payment defaults and delinquencies in the 2006 vintage.”

For deals issued in 2006, Standard & Poor’s said total delinquencies were higher than all recent vintages, and severe delinquencies were higher than all vintages except 2000. Total delinquencies for the year averaged 12.61 percent and loans seriously delinquent were approximately 5.97 percent.

“A comparison of cumulative losses for the same period revealed that the 2006 vintage experienced approximately 0.08 percent in realized losses, which exceeded those issued in 2000-2005 for the same time period,” said Standard and Poor’s. “We believe it is likely that this vintage will experience some adverse rating performance earlier than preceding vintages.”

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