Derivative Fitch has examined the potential impact of subprime closed-end second lien (CES) RMBS on CDOs rated by Fitch. In a statement released today, the rating agency said that these transactions are proving to be some of the worst performers through the first four months of 2007, though they represent only a small sub-sector of the overall subprime RMBS universe.

Fitch says it rates a total of 116 US CDOs with exposure to subprime CES RMBS transactions, though only 35 U.S. CDOs have exposure to the 2006 vintage subprime CES RMBS transactions that are experiencing the greatest stress. These US CDOs include 16 mezzanine structured finance CDOs, 11 high-grade structured finance CDOs, four synthetic structured finance CDOs, three commercial real estate CDOs and one market value structured finance CDO. There are also eight European CDOs with mild exposure to these assets.

The rating agency says the cumulative exposure to subprime CES RMBS transactions in these CDOs is not sufficient to cause it to place any tranche on negative watch. But it says the potential for negative actions on both high-grade and mezzanine structured finance CDOs increases dramatically where there are significant exposures to 2006 subprime CES RMBS and limited asset manager flexibility to sell assets.

Subprime CES deals differ from subprime first-lien deals in the timing of collateral loss, notes Fitch. Defaulted first liens go through a foreclosure and liquidation process that can take many months, often over a year, thus delaying loss realisation. Defaulted CES are typically charged off 100% 180 days after default, so losses feed through much more quickly.

Source: Derivative Fitch