No sooner had Fitch Ratings gotten more comfortable with credit losses than it starts warning on interest rate risk. It’s kind of back to the future for the Mortgage-Backed Securities (MBS) industry too. Because before the financial crisis, rate shifts were really the things keeping investors up at night.
Here’s Fitch’s macro credit team with a worked example in their latest report:
To take a practical example of the potential risks to MBS investors from higher interest rates, an unhedged Fannie Mae MBS (collateralized by 30-year fixed rate conventional mortgage loans) with a 3.5% pass-through rate incurred an approximately 9% price loss over the course of a few months, as Treasury yields increased 130 basis points (bp) between mid-October 2010 and mid-February 2011. By comparison, traditional, high-quality prime mortgages originated between 2000 and 2004 are expected to experience roughly 0.25% in cumulative credit losses, realized over the remaining life of the mortgage pools (e.g. up to 30-year term). Indeed, this 9% market value loss is nearly twice the cumulative expected credit loss of 5.0% for traditional prime mortgages originated between 2005 and 2008, the worst credit performance on record. Further exacerbating the risks to MBS investors in a rising rate environment is the potential for slowing prepayment rates, with many borrowers either unable (because of negative equity and/or tighter underwriting standards) or unwilling (because of escalating mortgage rates) to refinance..."
at http://ftalphaville.ft.com/blog/2011/04/14/546576/interest-rate-risk-hurts-hurts-like-a-9-per-cent-market-value-loss/
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