Fitch: Non-Agency REO Volume Jumps 441 Percent

It looks like investors and rating agencies alike are discovering REO, finally.

Unprecedented growth of U.S. real estate-owned property volumes and the costs needed to maintain these assets are hindering recoveries and may increase loss severities upon liquidation, presenting a lofty task ahead for RMBS servicers, according to Fitch Ratings in a new report released Tuesday morning.

By the end of last year, REO volumes for non-agency RMBS were up 441 percent over year-end 2005 levels, the rating agency said in a press statement. Such a rapid rise in inventory is leading to escalating loss severities, especially on subprime assets, which jumped to more than 54 percent for the 12-month period ended May 2008.

The primary driver of loss for investors continues to be reduction in home values, followed by the costs associated with the process of foreclosure/sale of REO and advances, which are further magnified by the extended timelines, according to senior director Mary Kelsch. That’s a sea-change from recent years, where investors cared little about REO and its contribution to loss severity.

Loss severity has climbed dramatically as the credit crisis has worn on. Click for larger view. (Source: Fitch Ratings)

“Foreclosure costs and other carrying costs and expenses associated with defaulted mortgage loans play a meaningful role in the determination of expected loss severity,” said Kelsch. “Additionally, they affect the analysis conducted to determine the sustainability of rating levels for existing transactions.”

Fitch said it had factored this new reality into its rating analysis, with projected average loss severities in excess of 60 percent for recent vintage subprime RMBS. The agency offered no word on how expectations for Alt-A loss severity have been factored into ratings stability — but the agency will soon be forced to grapple with similar issues in the area, as loss severity in Alt-A is starting to look a whole lot more subprime-like.

As HW has covered extensively as of late, various state and local jurisdictions have tried to stem the tide of rising foreclosures in recent months by proactively passing laws and becoming more aggressive in enforcing collection of fees and fines — a development that further pressures investor returns, Fitch said.

“As additional jurisdictions become more involved, servicers should have in place a process to identify changes in laws and ordinances, develop procedures to comply with such laws, implement and maintain controls to ascertain compliance, and ultimately mitigate losses due to associated fees and fines,” said Kelsch.

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

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