Lyudmila Udot, an analyst at credit rating agency Moody’s, said the exposure of non-conforming RMBS transactions to mortgage prisoners elevates the risk of performance deterioration in a stressed environment, which is credit negative for most transactions, especially for the 2006-07 vintages of RMBS.
Transactions with a high share of mortgage prisoners will have high losses, she said.
Mortgage prisoners are borrowers who are or were behind on their payments and have loan-to-value ratios exceeding 85% or who pay their mortgages on time but have interest-only loans with LTV ratios exceeding 100%.
She said mortgage prisoners are more vulnerable to macroeconomic or life event stresses such as unemployment or divorce.
As a result Moody’s said it maintained a higher future loss assumption for transactions with a high share of mortgage prisoners.
Portfolios with a high share of mortgage prisoners realise more losses from arrears because of higher defaults and loss severities.
Mortgage prisoners are more likely to default if they fall behind on their mortgage payments because they benefit less from loan modifications such as the capitalisation of arrears by their lenders, or the ability to transfer their mortgages to other lenders.
Udot said low-equity mortgage prisoners also incur greater losses upon default.
Overall Moody’s research showed a quarter of UK non-conforming borrowers are unable to refinance their mortgages, with the 2006-07 transactions the most exposed.
Transactions in the 2007-06 vintages contain most of the mortgage prisoners because older transactions benefited from house price increases, which lowered the level of indexed LTVs.
But Udot acknowledged there is no pattern of high arrears among mortgage prisoners in existing transactions because of low interest rates.
She said: “The bulk of interest-only loans are not due for refinancing until 2025 and the majority of non-conforming borrowers enjoy very low margins compared to current lending margin.
“In particular the current weighted average margin on a securitised non-conforming mortgage is 2.5% which is lower than both the best margin currently available for prime, low-LTV borrowers (2.8%) and the average margin on new lending from high street banks (3.1%).”
She added that long maturities and low margins mitigate the impact of limited refinancing options and result in no correlation between the share of mortgage prisoners and the level of arrears in the pool.
But she said: “The majority of non-conforming mortgages are not based on standard variable rates, which can be reset by a lender experiencing funding difficulties, as happened recently with a number of high street banks.”
The Moody’s research also found that around 80% of non-conforming mortgages track the sterling London Interbank Offered Rate while the remaining 20% track the Bank of England rate.
