NEW YORK--(BUSINESS WIRE)--Link to Fitch Ratings' Report: Exposure Draft: Canadian Residential Mortgage Loan Loss Model
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=701576
Fitch Ratings has released a proposed new model framework for estimating losses on prime Canadian residential mortgage pools. The proposed model is detailed in an exposure draft that Fitch published today.
Fitch's default risk estimates are based on a regression of loan and borrower attributes on roughly one million Canadian prime residential mortgages originated between 2003 and 2008. While Fitch obtained performance data from several major Canadian banking institutions, one data set in particular served as the foundation of Fitch's analysis due to its breadth and usability. Loss Severity (LS) data was provided by another large banking institution, which was factored into Fitch's assumptions for computing loan level LS.
Through the regression analysis, Fitch identified borrower equity as the strongest driver of default. The model framework includes the application of Fitch's proprietary sustainable home price model (SHP) to measure a property's sustainable value and - by extension - a borrower's sustainable loan-to-value ratio (sLTV) in deriving loan level default risk.
By focusing on sustainable home prices as measured through its SHP model, Fitch is able to take a forward-looking view on the potential for home price declines and the impact on borrower equity when projecting defaults and losses. The SHP model associates home price movements with drivers that Fitch found to be fundamental to the Canadian housing market such as GDP, unemployment, and mortgage rates, among others. Market value declines necessary to return home values to sustainable levels at the provincial level are applied to each loan to derive its sLTV.
In addition to a borrower's sLTV, Fitch noted five other borrower and loan attributes to be predictive of default. Borrower credit score ranks second with debt service ratio, loan purpose, occupancy, and property type rounding out the remaining attributes.
Fitch calculates loss severity by using an accounting based approach that utilizes provincial market value decline projections derived by the SHP model, quick sale adjustments, and liquidation cost assumptions as key inputs. In estimating the liquidation value of a property, appraised values are adjusted by the market value decline projection and quick sale adjustment.
A key feature of the model framework is the application of a dynamic two-step process to achieve stressed market value decline scenarios for each rating category. Home prices are first reduced to their sustainable value and then subjected to a further stressed market value decline assumption. Because of the limited performance data on the Canadian housing market during a distressed period, Fitch looks to the U.S. as a proxy for applying rating stresses to sustainable values.
Based on the results of the SHP model, Fitch currently estimates that home prices are overvalued by approximately 20% in real terms across Canada (with regional variations). Because of the effects of inflation and price momentum, Fitch does not expect that prices will fall by this amount immediately in practice. If growth halted tomorrow and prices began to drop, Fitch expects that it would take several years for home prices to revert to their sustainable values. This depends on a number of factors such as government support and credit availability. With this timeframe, the observed nominal decline in prices could be as low as 10%.
Fitch will apply the new model to analyze both new and existing ratings for covered bond programs as well as those supporting asset-backed commercial paper (ABCP) facilities and residential mortgage backed securities, if any.
Fitch invites feedback from market participants on the proposed methodology. Comments should be sent to 'CANMtgCriteria@fitchratings.com' by March 29. Following the review period, Fitch expects to finalize the criteria next month. Until then, Fitch will continue to apply its ResiLogic mortgage loss model to mortgage pools of existing covered bond programs and ABCP facilities. During this time Fitch will use its proposed methodology as an additional sensitivity analysis when assigning or reviewing ratings.
Fitch's 'Exposure Draft: Canadian Residential Mortgage Loan Loss Model' is available at 'www.fitchratings.com' or by clicking on the above link.
Additional information is available at 'www.fitchratings.com'.
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