May 07, 2020 / 11:34 AM / By Fitch Ratings / Header Image
Widespread use of coronavirus-related loan forbearance measures could affect structured finance (SF) transactions in ways that go beyond the initial risk of liquidity strain, Fitch Ratings says in a new report.
Forbearance should help to reduce ultimate losses on securitised assets, but will also distort the recognition of losses, either delaying it where suspended loans are considered as performing, or overinflating it where they are considered as non-performing. This could disrupt structural mechanisms that are contingent on documented definitions of asset performance, and, in some instances, negatively affect SF notes' ratings.
Reporting of loans in payment holidays varies between countries and sectors, and transaction documentation is unlikely to specify whether they should be considered as non-performing. In most European transactions, we expect suspended loans will be treated as performing unless investors actively lobby against it. In US RMBS, any loan that does not respect its repayment schedule will be considered delinquent.
Slower recognition of non-performing loans would delay switches from pro-rata note amortisation to sequential amortisation, or the deferment of interest payments to junior noteholders and/or equity holders, when these are triggered by asset performance deterioration. Other potential risks relate to interest-rate hedges that take performance metrics into account, and extension risk if loan tenors are extended, although we think these risks are less widespread.
Conversely, considering suspended loans as non-performing could be detrimental to the notes' ratings in those structures where the notes are deemed impaired (ie record a principal loss) when cumulative defaults exceed the par amount of the notes subordinated to them.
The servicer advancing framework mitigates liquidity risk in the US RMBS market. But the process for reimbursing servicers for advances made during payment holidays in some circumstances allows servicers to recoup advances from trust principal cash flows, which could cause undercollateralisation.
We believe that timely, transparent and comprehensive payment suspension reporting is of paramount importance not only for accurate credit ratings analysis but also for all market participants to assess the risks. For this reason, we would urge servicers to prioritise the development of payment suspension reporting. The share of suspended loans and post-suspension borrower performance is essential information.