Increasing arrears in Irish RPL RMBS transactions show no sign of slowing down, meaning there could be more pain for borrowers to come. Variable-rate mortgages continue to feel the brunt of rate rises leading to increasing payments. As a result, prepayments are increasing by borrowers capable of doing so. Nevertheless, our outstanding ratings in this sector have remained resilient to deteriorating arrears performance over the past 18 months, with nine transactions reviewed of which our ratings on 61 tranches all remained unchanged. In S&P Global Ratings' view, this is due to several factors: Rising house prices partially offsetting the credit deterioration from arrears, sequential payment structures, which increased credit enhancement particularly for senior notes, and protection to notes currently provided by reserve funds. Furthermore, because we incorporated an expectation of higher arrears in our analysis at closing for these transactions which has been observed, we reduce the stress applied. Higher arrears over the next 12 to 18 months for these transactions may lead to pressure on ratings, in particular on the junior notes which are first to bear losses. In this report, we take a closer look at factors underpinning the Irish RPL RMBS market's dynamics amidst prevailing uncertainty.

Chart 1

RPL RMBS Market Overview

RPL RMBS transactions began to emerge in the Irish securitization market in 2017 mainly comprising loan portfolios originated before the global financial crisis in 2008.

As property prices decreased from 2007 to 2013, the number of borrowers in arrears rose sharply, mainly due to high unemployment leading to an inability to meet repayments and/or borrowers having less incentive to pay due to having negative equity when comparing to the mortgage amount outstanding to the property value. Repossession of owner-occupied properties was not deemed a viable strategy both financially or politically given the volume of struggling borrowers. To address this, the Central Bank of Ireland (CBI) introduced the Code of Conduct on Mortgage Arrears and the Mortgage Arrears Resolution Process (MARP), in February 2009 and January 2011, respectively. This framework provided loan servicers with tools needed to adequately deal with long-term arrears, particularly relating to vulnerable borrowers (see "A Primer On Ireland’s RMBS Market," published on Oct. 10, 2023 for more details on the processes and timelines). Restructuring these loans provided a platform for these borrowers to find a sustainable solution to repay their mortgages and in most cases remain in their properties.

RPL RMBS pools generally comprise of restructured loans, a proportion that have never been restructured, and sub-portfolios previously from nonperforming transactions that became reperforming. The high volume of loans available accelerated issuance of RPL RMBS transactions. The proportion and complexity of restructured loans vary for each transaction. Earlier transactions had a larger volume of loans with single restructure arrangements (i.e., reduced payment, capitalized arrears, and term extension). Over time some of these loans typically have multiple restructures to ensure affordability and in some cases a warehouse or debt forgiveness element incorporated (see our Irish RMBS primer for more information on the loan restructure options and volumes over time).

Restructuring and in most cases selling the loans were instrumental in reducing the arrears on lenders' balance sheets allowing them to free up capital and to recommence normal lending volumes. Most restructured loans that were sold are now serviced by third-party servicers who work within the seller's remit.

Market Movements: Impact On RPL RMBS

Loan restructures up to 2022 were all completed when interest rates were at or close to zero percent. Most of these loans are variable rate, either tracking the ECB or a standard variable rate (SVR), meaning repayments in most cases were at their lowest level. Interest rates started to rise sharply since Q2 2022 to help curb rising inflation within the eurozone, increasing variable rate loan repayments as the higher rates were passed onto borrowers (see chart 2).

Chart 2

As of Q4 2023, the weighted-average interest rate for RPL RMBS transactions we rate was 5.38% compared to 3.69% for prime transactions (see chart 3). Approximately 19% of loans in prime transactions are on fixed rates with most set when rates were low, providing these borrowers with short-term protection against higher rates. Because almost 93% of borrowers in RPL RMBS transactions are on variable rates and do not have this option, they are exposed to rising rates (see example outlined in table 1). Up until Q2 2022, weighted-average interest rates for RPL RMBS transactions were either the same or lower than for prime RMBS mainly because of large proportion of tracker rate loans with low interest rates.

Chart 3

Table 1

Many of these borrowers have struggled to adjust to higher repayments and arrears in RPL RMBS transactions we rate are rapidly increasing. Chart 4 shows a clear credit deterioration in restructured loans from Q2 2022 when rates started increasing. The percentage of restructured loans not meeting their current restructure arrangement increased to 20.8% in Q3 2023 from 12.1% in Q1 2022. Furthermore, the percentage of restructured loans in arrears has increased to 25.4% from 20% for the same period.

Chart 4

Arrears in Irish RPL RMBS transactions that we rate confirm a similar trend (see chart 5). Arrears increased to 26.9% in Q4 2023 from 11.7% in Q3 2021, with 90+ days arrears increasing to 21.1% from 8.5%. With interest rates expected to remain at their current levels throughout 2024, we expect arrears in these transactions to deteriorate further as borrowers face higher repayments. The reserve funds in most of the transactions we rate have draws (see table 3) compensating for the low excess spread mainly due to the rising arrears and large proportion of tracker rate loans with small margins above the index.

Chart 5

In tandem with rising interest rates, the average conditional prepayment rate (CPR) for RPL RMBS transactions also increased (see chart 2). The CPR for these transactions tends to be lower than for prime transactions due to more vulnerable borrowers, negative credit features (such as title issues, adverse credit, or negative equity), or borrowers unwilling to refinance elsewhere because they want to keep certain loan features unavailable from other lenders (for example, split loan, interest-only, and part and part loans). The rise in the CPR along with the sequential payment structure for these transactions facilitate a faster paydown of the senior notes. However, over time it may lead to negative transition of the collateral, where only the weaker credit quality collateral remains in the pool later in the transaction's life which would potentially mean less available funds for the junior notes. Although this negative bias naturally occurs in all portfolios, when the credit quality of the borrowers varies significantly, the impact can be greater. We expect the CPR to revert to approximately 3%-4% as borrowers who can repay their loans early given the higher interest rates will have done so already.

House prices have been recovering since 2013, primarily due to limited housing supply. The house price index in third-quarter 2022 surpassed the 2007 peak. Rising house prices over the past decade has reduced the number of borrowers in negative equity and in some cases provided an exit strategy to repay their mortgages. This trend has reduced the weighted-average indexed current loan-to-value ratio, over time, positively impacting the weighted-average loss severity for Irish RPL RMBS transactions that we rate. This is one of the factors that is offsetting the higher weighted-average foreclosure frequency from increased arrears leading to relatively stable weighted-average loss projections.

Table 2 shows the average rating sensitivity for the reperforming transactions at closing and our 2023 reviews. At closing the ratings show resilience to the higher stress scenarios especially in the lower rating categories, which is positive given that these notes would be first affected by losses. The scenario analysis derived from the 2023 periodic reviews indicate that the ratings are less sensitive to rating movements mainly due to the build-up of credit enhancement. These reviews occur throughout the year and therefore in some cases may not capture the full rise in arrears or house price increases at the time of review. This may lead to greater rating sensitivity than outlined in the scenario analysis below.

Table 2

Chart 6

Servicing and fees

Loan servicing for almost all Irish RPL RMBS transactions have third-party servicers. These loan servicers have extensive experience across multiple asset classes. Since most of the borrowers in these transactions are deemed vulnerable, servicers have experience in working though the MARP with them to try and find a suitable loan restructure arrangement. RPL servicing can require substantially more time to periodically review the borrower's circumstances, as in a lot of cases they are vulnerable borrowers within some cases legacy mortgage issues, to see if viable arrangements still exist. Consequently, RPL RMBS servicing fees exceed those for prime transactions (see chart 7). The past two and a half years have seen RPL transaction servicing fees total on average 1.9 times the amount of prime fees.

More recently, the number of third-party servicers in Ireland has reduced limiting available servicer choices within the Irish market. Existing servicers have sufficient capacity and experience to sustain management of current RPL RMBS volumes. However, we foresee potential for implications to the wider sector given less competition which may increase future RPL RMBS administrator costs in transactions. We stress servicing fees as part of our cash flow assumptions for each transaction (see "Related Criteria").

Chart 7

Table 3

Related Criteria

• Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
• Methodology To Derive Stressed Interest Rates In Structured Finance, Oct. 18, 2019
• Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
• Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Principles Of Credit Ratings, Feb. 16, 2011
• Methodology For Servicer Risk Assessment, May 28, 2009
• Global Derivative Agreement Criteria, June 24, 2013
• Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012
• Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012

Related Research

• European Structured Finance Outlook 2024: Pushing On Through, Jan. 9, 2024
• U.K. RMBS Is Set To Withstand Payment Shock, Dec. 11, 2023
• European RMBS Index Report Q3 2023, Nov. 21, 2023
• Credit FAQ: How Do Product Switches Affect U.K. RMBS?, Oct. 30, 2023
• A Primer On Ireland’s RMBS Market, Oct. 10, 2023
• Asset Price Risks: Overvaluation Persists For Europe's RMBS And Covered Bond Markets, Oct. 4, 2023
• How Much Shock Can European RMBS Take?, June 8, 2023
• U.K. RMBS Audit Fees Could Heighten Tail Risk, March 16, 2023
• ESG Industry Report Card: Residential Mortgage-Backed Securities, March 31, 2021
• 2017 EMEA RMBS Scenario And Sensitivity Analysis, July 6, 2017
• Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016
• European Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016