DBRS Publishes RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology

DBRS, Inc. (DBRS) has today published its updated methodology, “RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology.” This methodology, effective as of the date of this press release, supersedes the previous methodology, “RMBS Insight 1.2: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology,” dated November 28, 2016.

In this methodology, DBRS provides the following key updates to (1) RMBS Insight, its residential loss model that estimates loan-level default probability, loss severity and expected loss for a pool of mortgage loans, and (2) its dynamic cash flow assumptions.
-- ZIP code-level Black Knight home price index.
-- Loss severity
-- Modified loans
-- Foreclosure timelines
-- Post-crisis loan performance
-- Streamlined cash flow assumptions

ZIP Code-Level Black Knight Home Price Index
DBRS now integrates Black Knight Home Price Index (HPI) in its RMBS Insight Model. Compared with the Metropolitan Statistical Area (MSA)-level Case-Shiller HPI used in the previous model versions, the Black Knight HPI incorporates property prices down to the ZIP code level. Such granularities, coupled with housing data by price tiers and property types, allow for increased precisions when DBRS indexes historical property values and forecasts future house prices, particularly with respect to geographically concentrated pools.

Loss Severity
Many crisis-era delinquent loans by now have either re-performed or liquidated. Foreclosure and delinquent inventories have decreased to their lowest levels in five years, although some of the more recent liquidated properties, due to their servicing techniques or geographic locations, had remained in the foreclosure pipeline for a long period. In this update, DBRS introduces additional independent variables to identify short sales, judicial states (or certain states with unique recovery patterns) and agency loans, as well as how long a property has remained in the liquidation pipeline. All of these variables impact recovery values and, hence, loss severities.

Modified Loans
With the gradual recovery of home prices and servicers’ focus on affordability and sustainability, re-default rates on modified loans have been improving year over year and have outperformed DBRS’s initial expectations. As a result, DBRS refits the odds ratios for various types of modification, resulting in in improved default probabilities for modified loans. That said, DBRS continues to apply a conservative overlay on modified loans. DBRS generally needs at least 12 months of proven payment histories, post-modification, to even consider the current status of modified loans.

Foreclosure Timelines
Foreclosure inventory continued to decrease on the national level. Average liquidation timelines, after lengthening for a long period of time, have now shown signs of decrease. In this update, DBRS re-calculates the foreclosure timeline from a state-specific hazard curve estimated from the MBSData LLC database. The new state-by-state timelines have generally shortened from DBRS’s previous estimates.

Post-Crisis Loan Performance
Post-crisis originations, whether agency or non-agency, have demonstrated excellent performance as reflected in delinquencies and losses. In addition to maintaining pristine loan characteristics, nearly all new mortgages have been underwritten to a stringent standard, particularly with respect to verifications of documents. In RMBS Insight 1.3, DBRS incorporates post-crisis performance for the past few years by re-estimating the odds ratios for American Securitization Forum (ASF) documentation type 5, which generally represents two years of income verifications, as well as the highest levels of asset and employment verifications.

Streamlined Cash Flow Assumptions
DBRS continues to incorporate a dynamic cash flow analysis in its rating process; however, the assumptions are streamlined to include 12 combinations of prepayment, loss timing and interest rate stresses – a baseline of three prepayment scenarios at 5%, 15% and 25% conditional prepayment rates (CPR), respectively; front- and back-loaded loss timing curves; and upward and downward interest rate stresses. An appropriate rating is one that can withstand the combination of DBRS-modeled cash flow stresses without the rated class incurring any interest shortfalls or principal writedowns.

DBRS does not deem the methodology updates to be material as RMBS Insight 1.3 substantially retains the core conceptual and structural framework of RMBS Insight 1.2, including:
-- Comprehensive coverage of RMBS assets;
-- Regional home price forecasts and economic factors, such as unemployment rates, per capita income and growth rate in civilian labor force;
-- Concentration risk by geography and loan size; and
-- Asset correlation and simulation approach to derive rating category stresses.

In addition, a preliminary impact analysis performed on a vast majority of the outstanding U.S. RMBS securities rated by DBRS does not indicate that the resulting rating differences are significant. A substantial portion of the reviewed bonds indicated a potential confirmation or upgrade. As the housing market, the DBRS home price forecast and transaction performance continue to improve, it is not surprising to see the number of upgrades exceed that of downgrades, as indicated by the impact analysis. DBRS expects the positive trend to continue for the foreseeable future. It is worth noting that the above impact analysis merely considers model-to-model, as opposed to model-to-actual, rating changes. The DBRS surveillance review does apply certain qualitative factors that may not have been accounted for in a typical loss or cash flow analysis. In conjunction with the updates, DBRS will review all affected securities and take timely and appropriate rating actions under the updated methodology if warranted.

Notes:
The full methodology providing additional analytical detail is available by clicking on RMBS Insight 1.3: U.S. Residential Mortgage-Backed Securities Model and Rating Methodology under Related Research or by contacting us at info@dbrs.com.

DBRS criteria and methodologies are publicly available on its website www.dbrs.com under Methodologies.