2008-01-31 20:31:52 -
- Fitch Ratings has announced a number of enhancements to ResiLogic, its U.S. RMBS mortgage default and loss model. These enhancements are designed to further Fitch's goal of incorporating a robust forecast of expected national and regional economic conditions into the ResiLogic model. The three major enhancements, which go into effect immediately, are as follows:
--Expansion beyond the currently
used state-level risk multipliers to include 25 specific metropolitan statistical area (MSA) multipliers;
--The MSA and state risk multipliers will now influence the loss severity (LS) for a defaulted mortgage, in addition to influencing the risk of mortgage default or frequency of foreclosure (FOF);
--In addition to these regional default risk multipliers, ResiLogic now incorporates a national risk index (NRI) which raises or lowers default and loss expectations in accordance with national macro economic trends. The NRI influences a mortgage loan's FOF and LS and is updated quarterly.
Along with these three primary enhancements, Fitch releases the most recent quarterly update to its regional risk multipliers.
The combined impact of these revisions generally produces a higher expected loss for subprime and Alt-A mortgages, and to a lesser extent, for prime mortgages. This is primarily due to Fitch's expectations of additional substantial stress on mortgage performance due to declining home prices and a weakening economy. These expectations are reflected in the regional risk multipliers and NRI. For example, a hypothetical newly originated pool of subprime mortgages having the same characteristics as those backing the ABX.HE 07-1 index, would have an indicated 'AAA' loss expectation of 43%, meaning that to be rated 'AAA' a bond would have to be able to withstand 43% losses on the mortgage pool. For comparison, the 'AAA' level as of the August 2007 revision of ResiLogic was 31%.
ResiLogic assesses a residential mortgage backed security (RMBS) pool using 13 credit dimensions for determining FOF, together with a slightly different set of 12 credit dimensions for LS. The credit dimensions reflect the risk of default and loss based on each loan's credit characteristics. ResiLogic adjusts these default and loss expectations based on risk multipliers assigned to economic regions. These risk multipliers are generated for Fitch by University Financial Associates, LLC (UFA), a mortgage risk analysis firm. For more information on the workings of ResiLogic, see the following reports published on Aug. 14, 2007 and available on the Fitch Ratings web site at www.fitchratings.com:
--'ResiLogic: U.S. Residential Mortgage Loss Model';
--'U.S. RMBS: Criteria Update to ResiLogic Model'.
While the UFA risk multipliers employed by Fitch since the introduction of ResiLogic have proven to be effective indicators of default risk trends for each state, economic conditions at the national level, such as real GDP growth, inflation, and interest rate fluctuations, also have a direct impact on housing and mortgage performance. Fitch tested UFA's NRI on the 1.6 million loan sample used in the development of ResiLogic and found that, when used in conjunction with the UFA risk multipliers, ResiLogic produced base case default and loss expectations that more closely matched actual performance than when using the risk multipliers alone.
As with the state and MSA risk multipliers, UFA will provide an updated NRI on a quarterly basis. The value of the NRI currently stands at 1.29 meaning that the base case FOF for a mortgage derived by its credit attributes will be multiplied by 1.29, in addition to the state or MSA multiplier based on the location of the mortgage. For LS, the combination of the state or MSA risk multiplier times the NRI becomes an additional dimension to the original 12 dimensions in the LS calculation. The historical peak of the index of 1.6 was reached in 1990.
Supplementing state-level risk multipliers with MSA-level multipliers provides increased granularity in the default and loss severity analysis since MSAs can exhibit disparate trends than those indicated at the state level due to variations in factors such as industry concentration/ diversification, employment growth and income levels. ResiLogic now includes risk multipliers for the top 25 MSAs ranked by volume of loans in Fitch rated RMBS.
Prior to these enhancements, expected case loss severities varied from historical averages as a function of the loan's credit attributes. The impact of regional economic conditions was accounted for in the FOF component. By applying UFA's national index and regional risk multipliers to both the FOF and LS analysis, Fitch's base case expected loss for newly originated loans will be better aligned with prevailing and forecasted economic conditions as well as UFA's five-year default projections and life of loan expected loss. Given Fitch's current expectations for continued home price declines, this change will generally result in higher expected case loss severities.
While Fitch does not anticipate that future revisions to loss expectations of this magnitude will be necessary, changes to the NRI and regional risk multipliers may cause expected losses and credit enhancement levels to rise. Fitch recognizes that the goal of proactively addressing worsening risk must be balanced with market participant's desire for credit enhancement indications to be relatively stable over time. Fitch is exploring additional revisions to its modeling methodology that will allow for greater stability of credit enhancement, particularly for investment-grade rated tranches, while still reflecting the risks inherent in a deteriorating credit environment. Fitch will be providing additional commentary on these revisions in the coming weeks.
The current values of the state and MSA risk multipliers are provided in a spreadsheet that will be updated quarterly. The spreadsheet is available on the Fitch Ratings web site at www.fitchratings.com in the 'RMBS' sector page under 'Special Reports'. The spreadsheet is also available on Fitch's Subprime markets page ('fitchratings.com/subprime') under 'Spreadheets'.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
Fitch Ratings, New York
Glenn Costello, +1-212-908-0307
Suzanne Mistretta, +1-212-908-0639
Media Relations:
Sandro Scenga, +1-212-908-0278
