Capital Markets

No Place Like Home: Rating Agency Revisions Continue

Fitch is the latest rating agency to change how it looks at subprimes. Its new methodology will even hit prime mortgages.
Alan RappeportAugust 7, 2007

Ratings agencies continue to recoil from the subprime mortgage mess, sharpening their tools in response to growing blame fanning in their direction. Fitch Ratings is the latest, opting to remodel its ratings criteria of mortgage-backed securities by attempting to be more sensitive to regional economic risks and the greater likelihood of defaults.

Fitch will assume higher levels of default and adjust its ResiLogic default and loss model to raise expectations for loan defaults. The change will affect its position in Alt-A, subprime, and prime mortgages.

“If home prices continue to decline, the number of borrowers with little or no equity will increase,” said Glenn Costello, managing director of residential mortgaged-backed securities (RMBS) at Fitch, during a conference call on Tuesday. The tighter criteria will increase default expectations by 20 percent, according to Costello. Default expectations for the 2/28 adjustable rate mortgages — often considered subprime — will increase by 22 percent, likely curtailing refinancing options for those borrowers.

Although prime credit performance has shown little sign of deterioration, Fitch said that prime borrowers are not immune to weakening home prices. The enhanced rating model will be more geographically sensitive to states that have seen the highest rate of defaults, most notably California.

“Housing markets in different geographic areas are sometimes very unique and it is difficult to apply one national number to specific areas,” Jon Thompson, investment officer in Advantus Capital Managment’s structured finance division, told CFO.com. “The more granular you can become in your process, I think that is so much the better.”

Also of note is that Fitch will change how it looks at debt-to-income (DTI) data, which determine which loans borrowers are qualified to take. Fitch said it was concerned by missing DTI data and that going forward, subprime loans with missing information will be assumed to have a DTI of 50 percent.

Meanwhile, Standard and Poor’s, a Fitch competitor, said Tuesday that it may downgrade 207 classes of Alt-A residential mortgage-backed securities due to rising delinquencies. The weak performance can be attributed to “home price declines; an environment of looser underwriting standards; risk layering; and speculative borrowing behavior,” according to Standard and Poor’s.

In July, Standard and Poor’s said that it would revamp its ratings methodology. “We will be increasing our review of the capabilities of lenders to minimize the potential and incidence of misrepresentation in their loan production,” S&P said last month. “A lender’s fraud-detection capabilities will be a key area of focus for us.” Its changes focus on evaluating executive leadership, underwriting and credit guidelines, and quality control for subprime lenders.

Moody’s, another ratings agency, struck a more moderate tone in its August ‘Special Comment’ on the impact of subprime exposure to U.S. investment and commercial banks. Regarding commercial banks, Moody’s said subprime exposure was “manageable” and “quite moderate” relative to the firms’ earnings capacities.

The outlook was less rosy for investment banks, which maintain less diversified earnings than their commercial counterparts, and no sector is immune. “Should further contagion within the credit markets occur, the banks and securities firms will likely be adversely affected,” Moody’s said.