Even when residential mortgage backed securities are based on high quality credit there is a risk for investors due to Canada’s “uncertain” housing market.
Fitch says that a recent RMBS transaction by a subsidiary of Canadian non-bank financial institution MCAP was backed by high quality credit mortgages, but the current housing market conditions mean an extended loan default risk.
The ratings agency did not rate this transaction but says that its rating criteria likely would have resulted in more conservative pool loss expectations than those implied by the transaction's credit enhancement.
The mortgage pool was strong with weighted-average credit scores above 760 and weighted-average loan-to-values below 70%.
Fitch also notes that MCAP is one of Canada’s largest mortgage financing companies and its subsidiaries are CMHC approved lenders with well-established performance records.
Also, the transaction mitigates the balloon risk of the underlying loans (which are contractually due in less than five years) by obligating the servicer to extend any borrowers that are not refinanced at the end of the contractual term.
However, the ratings agency says that non-banks have greater risk from economic stress with weaker credit.
“In Fitch's 'AAAsf' rating stress case scenario, we would assume all borrowers are extended, as refinancing opportunities (both with MCAP and other lenders) would be limited amid financial and housing market stresses” the ratings firm says. “Consequently, Fitch would estimate each borrower's risk of default through the full, approximately 25-year amortization period. Additionally, we would increase default projections, due to payment shock risk, since the loans would be assumed to extend at rates significantly higher than today's rates.”
Fitch adds that the combination of the longer loan default window and the payment shock risk would increase Fitch's loss expectations on the mortgage pool by approximately 1.75x, relative to a five-year term.
It says that the housing market's uncertainty adds to bondholder risk with the mortgage pool heavily concentrated with more than 80% of the loans located in Ontario and British Columbia.
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