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FHA Claim Denials Prompt Downgrade Warning

$3.5 billion in RMBS impacted

July 27, 2011

By staff

Uncertainty about the payment of claims has led to a downgrade warning on $3.5 billion in residential mortgage-backed securities filled with government loans.

On Wednesday, Moody's Investors Service said that it placed 193 RMBS from 39 deals on review for a possible downgrade. The transactions are backed by loans insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

The $3.5 billion in impacted RMBS were issued between 1998 and 2006.

The warning was prompted by "uncertainty about the claims that will be covered by HUD, sustained high
delinquency levels, expectations of continued weaknesses in the housing market, and high unemployment levels."

Moody's explained that as FHA volume has significantly increased during the past several years, the agency has been hit with more portfolio losses.

As a result, the Department of Housing and Urban Development, which houses FHA, has been more rigorously scrutinizing claims to identify servicing or underwriting defects that would serve as a basis for denial.

In addition, lenders can't collect on claims unless the property is in acceptable condition -- and HUD will not necessarily reimburse all of the costs to bring a property to an acceptable condition.

"The increased scrutiny by HUD and the uncertainty
pertaining to HUD ultimately paying claims have led to high volatility of our expectations on the losses that will be covered by FHA," the New York-based ratings agency stated.

Moody's explained that losses to date on FHA RMBS have been less than 1 percent despite high delinquency. Delinquency of at least 90 days on FHA-insured mortgages finished May at 8.2 percent.

But Moody's expects FHA losses to rise as HUD denies more claims.

Moody's noted that it already placed $0.4 billion in FHA-VA bonds on watch at the same time it placed U.S. government debt on downgrade watch.

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