The improving housing market and stable macroeconomic environment are helping to support the performance of legacy residential mortgage-backed securities performance.
Nonetheless, the sector still has persistent challenges to overcome, according to Fitch Ratings.
There are various signs of the turnaround in RMBS including, improving new delinquency roll-rates and declining loss severities on liquidated loans.
"These trends have resulted in improved rating stability and positive rating momentum in 2013," explained analysts for Fitch Ratings.
The credit ratings agency conducted rating reviews on every RMBS class in the last six month.
Year to date, Fitch has upgraded 480 RMBS bonds and current has a 'positive' outlook on roughly 800 bonds.
With that said, rating improvement will remain limited in the near term.
Pre-crisis RMBS transactions are still facing obstacles and it is also important to note that while the recent upgrades account for a small amount of the total securities that Fitch monitors, the credit ratings agency noted.
"Many RMBS securities continue to face sizeable risks that will limit the number of upgrades this year," Fitch analysts stated.
They added, "Among them are still high delinquency pipelines, increased tail risk caused by adverse selection and a high percentage of borrowers that remain underwater on their mortgages. What’s more, U.S. RMBS transaction cash flows remain vulnerable to servicer actions including advancing policies and modification reporting."
Going forward, future upgrade activity is expected to be concentrated among classes with relatively short remaining lives within sequential payment priority transactions, Fitch believes.
Fitch also noted collateral improved in 2006-2007 RMBS deals.
As a result, positive collateral trends will generally lead to improved principal recoveries on distressed classes rather than rating upgrades.
For instance, 94% of classes issued in 2006 to 2007 currently hold a rating below 'CCCsf', including 74% of classes, which have already defaulted, Fitch noted.
"More conservative rating stress assumptions than those applied prior to the financial crisis (particularly for investment-grade stress scenarios) will also stem the amount of rating upgrades," the credit ratings agency concluded.