Fitch Ratings is warning that the expiring homebuyer tax credits, the end of the Fed's MBS Purchase Program, and the growing maturity of various government loan modifications programs are likely to increase loss severities on distressed mortgage loans later this year. 

The report says that these factors as well as low interest rates and the Federal Reserve's $1.25 trillion mortgage-backed securities purchase program have led to an improvement in both home prices and loss severities since the second quarter of 2009, but this is unlikely to continue. 

The $8,000 tax credit for first-time homebuyers and $6,500 credit for move-up buyers will be effectively expiring with the deadline for signed sales contracts on April 30.  Buyers must complete the sale by June 30 so any drop off in sales figures will not be apparent until the third quarter but Fitch forecasts that the expiration of the program as well as the end of the Federal Reserve's purchases to increase negative pressure on both home prices and loss severities.

Fitch Senior Director Grant Bailey expects that loans that are found to be ineligible for government sponsored loan modification programs or failed modifications will also add to the supply of depressed residential inventory that will depress the market.  "Servicers are further along in identifying borrowers ineligible for modifications and will likely be more aggressive in liquidating these loans this year compared to last."

Bailey said that short-sales result in loss severities that are approximately 10 percent lower than losses on loans that are foreclosed or the deed taken in lieu of foreclosure so these more rapid and less costly alternatives may help stem rising loss severities.  The impact of the seasonal increase in real estate activity in the spring may also delay the immediate impact of the end of government support programs.

The Fitch report said that loss severity trends continue to be strongly dependent on home price trends.  In the two years prior to the recent improvement, national home prices dropped approximately 30 percent while the severity of loss on loans which incurred losses doubled to record highs of 43 percent for private-label prime loans, 58 percent of Alt-A loans, and 72 percent for subprime loans.

The release is available at (Logins required, but free)