Adverse selection rises as RMBS outstandings fall
S&P reported that arrears on prime mortgage-backed securities jumped in January to 1.39 per cent of the underlying mortgage outstandings, from 1.25 per cent at the end of December. However, mortgage outstandings resumed their declining trend over the month to fall to just A$95 billion.While the rise in proportional arrears is being attributed to the impact of rising mortgage rates and the normal seasonal impact of Christmas spending, adverse selection could now also be playing a role. S&P is of the view that continuing mortgage rate increases could push arrears rates even higher. Subprime arrears rates also increased by 51 basis points to 12.08 per cent. With no new issuance of subprime RMBS since December 2008, outstanding subprime mortgages have fallen to just A$3 billion. Adverse selection must now be a significant factor in these arrears levels and can be expected to drive arrears rates even higher as time goes by.S&P also affirmed the ratings on all classes of subprime and nonconforming RMBS issued by Pepper Residential Securities Trust No. 6. The rating affirmations reflect its view that the rated notes are adequately supported to withstand stresses that are commensurate with the current rating levels. Although the credit enhancements as a percentage of the outstanding balance have built up as the portfolio amortized, in S&P's opinion the current portfolio composition remains susceptible to adverse selection risk, and the pro-rata pay-down of the notes may limit further build-up of credit support to the rated notes.