Loss severities are expected to increase between 5% and 10% on residential mortgage-backed securities in 2011 as loss mitigation costs and foreclosure expenses go up, according to Fitch Ratings. This, analysts said, will push servicers to short sales. The loss severity, or the percentage of principal lost when a loan is foreclosed, on prime mortgage loans is currently at 44%. This, according to Fitch, will increase to between 49% and 54% in 2011. For Alt-A loans, the current 59% loss severity should increase to between 64% and 69%. Currently, the loss severity on subprime loans is 75%, but Fitch predicts it will increase to 80% and 85% by the next year. These loss severities had remained stable for more than a year. In the second quarter of 2009, the amount a lender could recover when it foreclosed on a mortgage was propped up by slightly improving home prices, low mortgage rates, homebuyer tax credits and government-funded modifications. With the tax break expired, mortgage rates increasing and underwhelming modification numbers pose many tough challenges for the housing market in 2011. Increased servicing costs from pressures to modify more loans and recent problems with many banks’ foreclosure processes will drag down the amount of principal banks can recover from a foreclosure. Borrowers average 19 months without making a payment before they are foreclosed upon, a record high, and Fitch projects this to increase to 25 months in 2011. Fitch Managing Director Diane Pendley said the answer for some lenders is a short sale. “Servicers are increasingly turning to less costly alternatives to foreclosure such as short-sales,” Pendley said. Recovery rates on short sales are usually 10% higher than foreclosures. Pendley said servicers are also reducing the amount of payments they advance to securitization trusts from delinquent borrowers, particularly on subprime loans. In November, Fitch said, servicers advanced only roughly 60% of delinquent subprime loans, down from 90% at the beginning of 2009. Write to Jon Prior.

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