Moody’s: Rapid Amortization on HELOCs a Concern

Moody’s Investors Service said Wednesday that while Countrywide Financial Corp.’s recent fourth quarter earnings report was “within expectations,” a new loss component disclosed by the nation’s largest lender may portend problems for other large securitizers of HELOCs.

The area of concern: so-called rapid amortization.

Buried in Countrywide’s $831 million fourth quarter write-down of residual interests, Moody’s said, was a $704 million charge related to “rapid amortization” on home equity line securitizations.

Moody’s characterized this loss component as new, and one that may impact other mortgage operations with large HELOC securitization exposure. From a press statement (registration req’d), a discussion of the issue that is very much worth reading [breaks added to improve readability]:

For home equity line securitizations, Countrywide, as the servicer, makes advances to borrowers when they request a draw on their line of credit. In normal circumstances Countrywide’s reimbursement for these advances would have a higher priority to securitization cashflows than payments made to securitization trust note holders.

However, in those situations where losses on the loans in the securitization result in claims on the insurance policies supporting the securitization above a certain threshold or duration, the priority of payment shifts. In this situation Countrywide is reimbursed after the trust note holders, insurance providers and other parties to the securitization receive the cashflows to which they are entitled. This is referred to as rapid amortization.

The charge of $704 million represents a liability for losses on estimated advances Countrywide could be required to make on securitizations that have entered or are expected to enter rapid amortization status.

It is important to note that this exposure is not reflected in the traditional balance sheet “residual” amount recorded with a securitization transaction. Prior to rapid amortization occurring, or being highly probable of occurring, this exposure is a contingent liability and not reflected on balance sheet.

Moody’s vice president Craig Emrick said the issue represented an industry first.

“This issue has not been discussed by other large securitizers of home equity lines but it could have broader impact than just Countrywide,” he said.

For more information, visit http://www.moodys.com.