UK Homes in Prime Pools 15% Underwater
15% of prime mortgages in the UK serving as collateral in residential mortgage backed securitization are currently in negative equity, or underwater, according to Fitch Ratings. The rating agency adds it expects this number to increase to 34%, meaning home prices in one of Europe's hotter boom markets will decline another 14% from today's value. "While prime borrowers are unlikely to default solely because the value of their house is less than the outstanding balance of their mortgage, Fitch expects default rates to be higher for borrowers in negative equity," says Ketan Thaker, Director in Fitch's European RMBS team. "Borrowers with equity in the property have options available to them in case of financial distress that borrowers in negative equity do not, for example sale of property, remortgaging, better availability and pricing of products, and the withdrawal of equity to fund temporary cash shortage, which could help avoid foreclosure." Luckily, Fitch says it factored all this into its ratings, so it does not expect downgrades as a result. But that is the least of UK RMBS worries at the moment, prime or not. Analysts at UniCredit cited in weekly research that the UK government is reportedly trying to work out a partial debt-buyback plan for nationalized bank Northern Rock's Granite RMBS trust. Fitch estimates that Granite, with 32% of loans (by value) in negative equity, has the highest proportion and Barclay's Gracechurch pool, with only 2% of loans in negative equity, has the lowest proportion. These significant relative differences will persist if house prices fall further. The UK Financial Services Authority (FSA) also issued a clear warning to specialist mortgage lenders and third-party administrators that some current practices are not satisfying FSA guidelines for responsible lending or treating customers fairly when it comes to modifying securitized loans for underwater or otherwise struggling borrowers. The FSA review explicitly targets the UK non-conforming RMBS sector, according to Barclays analyst Dipesh Mehta. "With four firms referred by the FSA for investigation and third-party servicers also cited to improve practices to help borrowers that are in arrears, we may see a number of UK non conforming transactions affected, particularly so as the significant majority have outsourced their servicing capabilities to various third-party servicers, such as Homeloan Management and Capstone," Mehta says. "Loan modifications have always been a contentious issue for RMBS investors," he adds. "By helping the levels of arrears in a transaction, they may be postponing the inevitable foreclosure, which could harm the transaction further in a declining housing market." Mehta adds that slower amortization of the notes due to lower CPR will equal a reduction in excess spread if the monthly mortgage payment is reduced. The excess spread pays out along the capital waterfall. "But what is a further risk is the uncertainty that this brings, with rating agencies possibly taking action as the process described in the securitized transaction documentation differs to what was assumed at issuance," he said. Write to Jacob Gaffney.