ABS Collateral Performance Expected To Worsen In US; Improve in UK

UK and US house prices will cease falling in Q4 2010 according to the latest quarterly Standard & Poors survey. Respondents to S&Ps quarterly survey of asset backed securities (ABS) market participants suggested
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UK and US house prices will cease falling in Q4 2010 according to the latest quarterly Standard & Poors survey.

Respondents to S&Ps quarterly survey of asset backed securities (ABS) market participants suggested a bottoming out of US, UK, Dutch and Italian house prices before the end of 2010 with only Spains housing market expected to keep falling until Q2 of 2011. US national home prices are predicted to average a 5% decline in the next 12 months compared to projections of a 5.8% fall in UK prices.

Respondents to the survey also held differing assumptions over the performance of mortgages underlying US and European Residential Mortgage Backed Securities (RMBS), with default rate forecasts for nearly all asset classes of US RMBS collateral increasing dramatically, contrasting to improving default rate expectations in the UK.

The latest quarterly valuation consensus survey, involving buy side and sell side institutions in the structured finance market, was carried out in January 2010 by Standard & Poors independent Fixed Income Risk Management Services (FIRMS) group.

Regarding default rate assumptions on the underlying mortgages behind RMBS, estimates on virtually all classes and vintages of US collateral have increased significantly since the previous quarterly survey. In some cases, 12-month default rate expectations for US RMBS collateral have doubled. For example, 2004 vintage US Sub-Prime adjustable rate RMBS collateral default forecasts have increased from 13% polled in Q3 to 26% in Q4.

This contrasts with a marked improvement in default rate expectations across all classes and vintages of UK RMBS collateral. For UK Non Conforming Loan (NCL) RMBS, the predicted mortgage default rate for an average of vintages over the next 12 months is 4.61%, a fall from 9% polled in Q3. And for UK Prime mortgage default rates the 12-month average forecast for all vintages also fell, from 2% in Q3 to just 1.09%.

The Q4 survey also reveals how much new RMBS issuance is expected by investors in 2010. In the US, most respondents feel that the total non-agency RMBS issuance will amount to less than US $10 billion. In the UK, for Prime UK RMBS, the consensus appears to be for between 11 billion and 25 billion of new issuance. The remainder of the European buy side (33%) felt the figure would be more like 1-10 billion, while the remaining sell side (29%) predicted as much as 25-100 billion.

S&Ps valuation consensus survey was initiated in January 2009, inviting market participants to provide details of their methodologies when valuing structured finance assets and to give their expectations of four key valuation inputs on an asset level, vintage level and on an individual deal level. The key assumptions are constant default rates, loss severity (the severity of any losses occurring on the collateral in default), prepayment rates, and recovery lag.

Improving transparency around all the processes involved in a valuation is central to re-establishing investor confidence in the ABS markets, says Peter Jones, a senior director of S&Ps Valuation & Risk Strategies group at FIRMS. By comparing the results against previous quarters, it is possible to observe both investors changing predictions for the performance of RMBS collateral and any developing trends in valuation methodologies across the buy and sell side sides of the market.

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