Fitch tightens criteria for mortgage bond ratings

NEW YORK Aug 6 (Reuters) - Fitch Ratings on Monday said it will assume higher rates of default on U.S. residential mortgage loans when rating securities backed by those loans.

The ratings agency said it is making several changes to its ResiLogic default and loss model for prime, subprime and Alt-A mortgages, which will have the effect of raising its expectations for loans defaults in new deals.

Fitch is now placing more weight on regional economic risk to better account for deteriorating housing prices, which the agency said is the "greatest risk to new U.S. RMBS," or residential mortgage-backed securities.

The greater weighting of regional factors in the model will have the effect of "raising default expectations by approximately 20 percent, reflecting the adverse trends in the states that contribute the majority of mortgages to RMBS, most notably California."

Another change was prompted by the recent decision by many large mortgage originators to stop offering various adjustable-rate mortgages, which offer low introductory teaser rates that reset higher after a period of time.

"With the recent decision by many large originators to cease origination of 2/28 hybrid ARM mortgages, Fitch anticipates that refinancing options for existing 2-year hybrid ARM borrowers will be sharply curtailed," the ratings agency said.

The absence of a comparable product is likely to expose more borrowers to payment shock risk and increase defaults when rates reset higher, Fitch said.

"Expected default rate multipliers for 2/28 ARMS are increased by 22 percent and by 12 percent for 3/27 ARMs," Fitch said. Expected default rates for ARMs with adjustment terms below two years are increased by 30 percent, Fitch said.