Collateral performance will continue to be weak for all U.S. structured finance sectors next year, according to Fitch Ratings in its 2010 outlook report. Downgrades will likely continue in the residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and collateralized debt obligations (CDOs) sectors, though at a slower pace.
Protracted illiquidity and refinance risk remain Fitch's chief concerns for CMBS in 2010. Commercial real estate will also continue to lag the broader economy, with operating cashflows expected to decline across all property types over the next 18-24 months.
Losses will remain elevated for recent vintage CMBS, though ratings should remain stable since Fitch's third quarter of 2009 prospective ratings review factored in steeper future performance declines over the next 18-24 months.
Fitch is reviewing pre-2006 vintage CMBS and expects downgrades for these older vintages into 2010. However, ‘the magnitude of downgrades is expected to be less severe due to seasoning, defeasance and the loans generally not underwritten as aggressively as those at the peak of the market,’ says Managing Director Bob Vrchota.
Fitch is projecting CMBS loan delinquencies to reach 6% by the end of the first quarter, growing to 12% by the end of 2012. Pre-2006 vintage downgrades are likely for bonds rated lower than AAA, Fitch adds.
While temporary government support programs are providing some relief for the residential market, it will not be enough to stem rising delinquencies and losses for RMBS in 2010, the agency says.
"Negative equity, high redefault rates on modified loans and additional rises in unemployment may deter any positive momentum for RMBS," says Senior Director Grant Bailey.
Downgrades for RMBS will continue to outnumber upgrades, though they will not be as severe as in prior years. Another silver lining is the high recovery rates that Fitch is projecting for prime and Alt-A RMBS that have been downgraded to distressed levels.
Fitch projects that national home prices will fall an additional 10% in 2010. Redefault rates could reach 50% for prime loans and 65%-75% on Alt-A and subprime loans. The agency also projects a 95% recovery rate for distressed prime RMBS, an 80% recovery rate for distressed Alt-A RMBS and a 50% recovery rate for distressed subprime RMBS.
Asset performance will continue to deteriorate for all major U.S. CDO sectors in 2010. While recently reviewed CDO notes that have retained high investment-grade ratings maintain sufficient cushion, lower rated classes will generally be more susceptible to negative rating actions.
Significant rating stress will continue for both trust-preferred security and mortgage CDOs, while elevated high-yield corporate default rates will continue to pressure corporate CDOs and collateralized loan obligations, which have performed relatively better than any of the other structured credit asset classes. Refinance risk also remains a major focus for CLOs.
‘High-yield bond issuance and maturity extensions in 2009 have addressed less than 10 percent of the leverage loans requiring refinancing by the end of 2014,’ adds Managing Director Kevin Kendra. ‘Traditional bank loan activity will remain challenged as tighter lending standards limit refinancing opportunities to the higher-quality borrowers.’
SOURCE: Fitch Ratings