DS News

28 RMBS IN 2019 e issuance of residential mortgage-backed securities (RMBS) is likely to end 2018 with an increase of 63 percent over 2017, according to an outlook on RMBS released by Kroll Bond Ratings Agency (KBRA). e outlook reviewed and presented updates to issuance volume trends and forecasts, spreads, and collateral performance trends. It also recapped some of the highlights of the 2018 RMBS market and the themes that would shape it over the next year. e report pegged the Q 4 RMBS volume in excess of $10 billion, down from a post- crisis high of over $15 billion in the second quarter of the year, "but still well above recent years' volume." e report indicated that if the U.S. GDP was to grow at the steady pace it has this year, until July 2019, the year could see "another robust issuance year in 2019." However, factors such as higher interest rates, home price moderation, and widening spreads that have been experienced by the market in the last few weeks are likely headwinds that might pull down the performance of RMBS next year, the report revealed. "Given the potential downside risks, we aren't forecasting issuance growth in 2019, but believe issuance will be comparable to 2018 levels," KBRA said in the outlook. Breaking up RMBS issuances, KBRA said that while each issuance segment grew year- over-year, the gains were primarily driven by prime transaction issuance, which grew by $10.7 billion, nearly doubling from 2017. Non- prime issuance also added to the gains and was expected to end the year at just under $10 billion. Credit Risk Transfer (CRT) issuance remained mostly flat at around $15 billion, KBRA reported, showing a 5 percent increase over last year. ough prime issuance doubled in size, nearly 75 percent of the increase was attributable to prime sub-types which had contributed only 20 percent of 2017's prime issuance volume. ese sub-types include agency-eligible loans (both investor occupancy and noninvestor occupancy) and expanded prime loans. KBRA projected expanded prime sub-types to have the most upside for issuance volume in 2019. However, the rating agency said that it also expected them to be affected by similar dynamics that have been impacting non-prime issuance. e outlook also expected non-prime issuance to expand modestly in 2019 due to a number of factors that would increase the origination volume and related issuance volume. "In particular, increased attention to the space as compared with the past few years of relatively high coupon lending and tighter spreads have caused originators to focus on alternative loan product offerings, process, and technology to increase profitability," KBRA projected. "Positive early performance of non-prime loans and a favorable economic environment have also encouraged originators to continue expanding products, increasing loan supply. THE IMPACT OF PRICE TRENDS ON MORTGAGE DEFAULTS A number of factors drive default rates in mortgage, but a new study by Collateral Analytics has found that price uncertainty and actual and expected home equity are important drivers. To reach this conclusion, researchers Dr. Michael Sklarz, Dr. Norman Miller, and Anthony Pennington-Cross analyzed the typical pattern of mortgage default in response to negative price trends and high loan-to-value (LTV) mortgages using Chula Vista, California as an example since it was a market with higher than average LTV loans. en they compared several local markets in San Diego County by ZIP code where average LTVs and the use of mortgages varied systematically to create a map of ZIP codes with default rates. Explaining their rationale behind the study, the researchers said, "When home values decline to the point where borrowers have no equity or negative equity, and they see no immediate reversal in local price trends, they often decide to default. is is sometimes called "rational default" or "strategic default", and while it may affect credit ratings for some time, U.S. borrowers know they will seldom be chased for mortgage balance deficiencies. is encourages the decision to default when the mortgage balance appears to exceed the value of the home. is creates a situation where mortgage lenders are on the short end of a "heads I win, tails you lose situation". If prices go up, borrowers' benefit, but if prices go down too far, the mortgage lender suffers." Looking at Chula Vista, the researchers found that loans originated in 2000, 2001, 2002, and 2003 were the beneficiaries of strong price increases of 12 percent, 14 percent and 25 percent in average home prices, so when prices reversed in 2006 "there was still sufficient cushion to preserve real home equity" when other factors for default such as income-to-mortgage payment ratio, credit behavior, job loss, and available liquid assets to make mortgage payments were not taken into consideration. However, mortgage loans originated in 2004 saw increasing default rates peaking out in 2007 as home prices started to decline. e study found that of the loans originated between 2005 and 2007 at the peak of home prices during that cycle, half or more defaulted in the subsequent years. "e high LTV loans declined as subprime loans disappeared, however, the FHA and loan modifications allowed many homeowners to continue with high LTVs through 2012," the study revealed. Expanding this example to other markets, the researchers observed that markets with higher LTV mortgages and similar price trends as Chula Vista defaulted at much higher rates, making it clear that "home price trends dominate the decision of home borrowers to default."

• Cover