Increasing costs associated with managing and liquidating foreclosured properties are squeezing mortgage servicers and could result in even larger losses, according to a new report from Fitch.

Unprecedented growth of U.S. real estate-owned [REO] property volumes and the costs needed to maintain these assets are hindering recoveries and may increase loss severities upon liquidation, Fitch says in a new report.

By the end of last year, REO volumes for non-agency RMBS were up 441% over year-end 2005 levels. This rapid rise is leading to escalating loss severities, especially on subprime assets, which jumped to more than 54% for the 12-month period ended May 2008 and is likely to increase.

The primary driver of loss continues to be reduction in home values, followed by the costs associated with the process of foreclosure/sale of REO and advances, which are further magnified by the extended timelines, according to Senior Director Mary Kelsch.

"Foreclosure costs and other carrying costs and expenses associated with defaulted mortgage loans play a meaningful role in the determination of expected loss severity," said Kelsch. "Additionally, they affect the analysis conducted to determine the sustainability of rating levels for existing transactions."

Fitch has factored this into its rating analysis, with projected average loss severities in excess of 60% for recent vintage subprime RMBS.

Various state and local jurisdictions have tried to stem the tide of rising foreclosures in recent months by proactively passing laws and becoming more aggressive in enforcing collection of fees and fines associated with new and/or existing laws. "As additional jurisdictions become more involved, servicers should have in place a process to identify changes in laws and ordinances, develop procedures to comply with such laws, implement and maintain controls to ascertain compliance, and ultimately mitigate losses due to associated fees and fines," said Kelsch.

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