While the Federal Reserve will most likely raise rates gradually
beginning around midyear, faster increases and a corresponding shock to
the economy would likely leave most US structured finance ratings
untouched. However, it could slow the refinancings that will be crucial
to the CMBS market and could hurt some RMBS deals that include legacy
adjustable rate mortgages, Fitch Ratings says.
Fitch created a shock scenario to help understand how faster rate
increases and a decline in the US economy would impact the structured
finance market. We expect the Fed's actual average policy rate for 2016
to be 1.6%. In the shock scenario, we assumed inflation would rise to
4.5% and force the Fed to raise its annual target to 4% in 2016. We also
assumed 0% real US GDP growth, unemployment rising steadily to 7% and
the yield on 10-year Treasuries reaching 5.5% in 2016.
Most ratings would be stable under this scenario. In our view, the Great
Recession has already tested most legacy transactions and those ratings
have already been adjusted. And, the economic shock waves in the
scenario could be partially offset by the decline in crude oil, if
prices remain at or near their current levels through 2016. The
generally negative impact on the still-challenged housing market could
raise consumer debt costs and slow spending activity. However, lower gas
prices and heating oil costs could also make it easier for consumers to
make debt service payments.
Some CMBS and RMBS subsectors, however, could be impacted directly and
indirectly under this scenario.
The CMBS market would see the greatest impact, in part due to the
maturity wall that would coincide with the scenario's most significant
disruption. Approximately $177 billion of multiborrower, fixed-rate
transactions are scheduled to mature from 2015 to 2018. The weighted
average coupon for those loans is about 5.7%. As rates increase,
potential loan proceeds would generally decrease. Demands for more
equity would be unlikely to be met as many of the loans maturing in the
next several years are already over-leveraged.
RMBS transactions issued prior to 2010 would also be at risk in the
scenario. Pools with relatively high numbers of adjustable-rate
mortgages would be particularly exposed to higher payments. A rise in
rates and an economic slowdown would also likely affect home prices,
adding negative pressure on legacy borrowers with little or no home
equity. Fitch would expect borrowers in transactions issued since 2010
to be able to absorb the changes in this scenario without a significant
increase in ratings risk due to strong home equity positions and large
The impact on ABS would likely be small. The impact on autos and student
loan ABS performance would be minimal. Certain credit card ABS metrics
would see some variations that would not be likely to change ratings.
The knock-on effect from other macro-economic stresses such as rising
unemployment and other labor market strains could have a more
significant impact on ABS performance variables across the board.
However, we would expect ABS ratings volatility under the scenario to be
relatively low, similar to its performance during the Great Recession.
For more information, see Fitch's new report: "U.S. Structured Finance
Interest Rate Shock Implications" available at the above link or on www.fitchratings.com.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit
market commentary page. The original article, which may include
hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com.
All opinions expressed are those of Fitch Ratings.
Applicable Criteria and Related Research:
US Structured Finance Interest Rate Shock Implications
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