As the buzz in US commentary remains focused on whether the financial market is seeing bottom, the recession and its pressure on residential mortgage performance in the United Kingdom will likely worsen, according to Fitch Ratings. The deteriorating mortgage performance, seen heavily in UK and Spanish residential mortgage-backed securities (RMBS), led to downgrades of 91 tranches of European RMBS, compared with only 14 upgrades in Q209, according to quarterly commentary. The quarter saw an emergence of the interest deferral mechanism -- first used in European RMBS during Q209 -- which arrives in response to the tightened supply of revenue funds caused by rising arrears, repossessions and defaulted loans, said Fitch analyst Sanja Paic. When cash reserve funds are pressured to cover interest and losses, interest is sometimes deferred to junior and mezzanine notes, in order to protect senior note holders. The interest deferral mechanism comes about through several triggers. One instance that triggers the mechanism occurs when the volume of defaults in an RMBS transaction breaches a prescribed percentage -- 3.9% in an example provided by Fitch -- causing the deferral of class-D interest payments. Interest on class-D notes then ranks subordinate to the redemption of principal. Fitch sees more Spanish RMBS transactions likely to hit their prescribed default targets in forthcoming interest payment dates. Another trigger scenario occurs when funds generated in a transaction are insufficient to pay interest due on mezzanine, junior and excess spread notes, causing the deferral of interest payments until the next payment date. Fitch noted its ratings on such classes where interest is deferred will likely range from single-C to triple-C. Rising unemployment and falling home prices led to arrears throughout European RMBS in the quarter. Germany held relatively steady with 12 transactions downgraded and 12 affirmed in Q209. The Greek property market remains resilient with one RMBS transaction upgraded and 27 affirmed in the quarter, although analysts see evidence house prices begin to decline. Ireland suffers with the financial crisis, with house prices falling month-on-month for nearly two and a half years and now holding in-line with levels seen in the summer of 2004, analysts said. Irish RMBS, however, remains largely untouched with no ratings actions in the quarter, five transactions bearing 'positive' current outlooks and another 24 holding at 'stable' outlooks. Deteriorating unemployment levels and house price declines keep Spain under pressure as one of the European countries most affected by the financial crisis. Fitch downgraded 56 transactions in the quarter, upgraded two and affirmed 82 others. UK's prime transactions received no ratings action in the quarter, while analysts see an indication of slight improvement in house prices, analysts said. The UK non-conforming transactions took 18 downgrades, two upgrades and 21 affirmations in the quarter. Write to Diana Golobay.