NEW YORK--(BUSINESS WIRE)--Fitch Ratings expects to assign the following ratings and Rating Outlooks to Fannie Mae's inaugural risk transfer transaction: Connecticut Avenue Securities Series 2013-C01:
--$337,500,000 class M-1 Notes 'BBB-sf'; Outlook Stable.
The $337,500,000 class M-2 Notes will not be rated by Fitch.
The 'BBB-sf' rating for the M-1 notes reflects the 1.65% subordination provided by the 1.35% class M-2 Notes and the non-offered 0.30% B-H Reference Tranche. The notes are general senior unsecured obligations of Fannie Mae (rated 'AAA' with a Negative Outlook by Fitch) subject to the credit and principal payment risk of a pool of certain residential mortgage loans held in various Fannie Mae-guaranteed MBS.
Connecticut Avenue Securities 2013-C01 (CAS 2013-C01) is Fannie Mae's inaugural risk transfer transaction issued as part of the Federal Housing Finance Agency's Conservatorship Strategic Plan for 2013 - 2017 for each of the government sponsored enterprises (GSEs) to demonstrate the viability of multiple types of risk transfer transactions involving single family mortgages with at least $30 billion of unpaid principal balance in 2013.
The objective of the transaction is to transfer credit risk from Fannie Mae to private investors with respect to a $28.0 billion pool of mortgage loans currently held in previously issued MBS guaranteed by Fannie Mae where principal repayment of the notes are subject to the performance of a reference pool of mortgage loans. As loans become 180 days delinquent or other credit events occur, the outstanding principal balance of the debt notes will be reduced by a pre-defined, tiered loss severity percentage related to those credit events.
While the transaction structure simulates the behavior and credit risk of traditional RMBS mezzanine and subordinate securities, Fannie Mae will be responsible for making monthly payments of interest and principal to investors. Because of the counterparty dependence on Fannie Mae, Fitch's expected rating on the M-1 notes will be based on the lower of: the quality of the mortgage loan reference pool and credit enhancement available through subordination; and Fannie Mae's issuer default rating. The M-1 notes will be issued as uncapped LIBOR-based floaters and will carry a 10-year legal final maturity.
KEY RATING DRIVERS
Prime Quality Mortgage Reference Pool: The reference mortgage loan pool for the transaction consists of high-quality prime mortgages acquired by Fannie Mae during the third-quarter 2012. The reference pool comprises 117,745 loans totaling $28 billion. Weighted average combined-loan-to-value, debt-to-income, and credit scores are 75.9%, 31.7%, and 765, respectively. All loans were underwritten with full documentation. The reference pool also benefits from significant geographic diversity.
Improved Aggregator Platform: Fannie Mae's risk management/quality control processes have evolved over time, and some were recently implemented in conjunction with the rep and warranty framework introduced for loan purchases this year. However, the majority of the processes were developed following the crisis and implemented prior to 2013. Based on a comprehensive review of the platform, Fitch believes that Fannie Mae has a robust lender quality assurance and loan quality control review platform in place. Fitch applied a modest reduction to its default expectations to account for the lower risk associated with the recent acquisitions.
Fixed Loss Severity: One of the unique structural features of the transaction is a fixed-loss severity schedule that is tied to cumulative net credit events. If actual loan loss severity is above the set schedule, Fannie Mae absorbs the higher losses. Fitch views the fixed loss severity positively as it reduces uncertainty that may be driven by future changes in Fannie Mae loss mitigation or loan modification policies. The fixed severity also offers investors greater protection against natural disaster events where properties are severely damaged and there is limited or no recourse to insurance.
Advantageous Payment Priority: The payment priority of the M-1 class will result in a shorter life and more stable credit enhancement than mezzanine classes in private-label (PL) RMBS, providing a relative credit advantage. Unlike PL mezzanine RMBS, which often do not receive a full pro rata share of the pool's unscheduled principal payment until year 10, the M-1 class can receive a full pro rata share of unscheduled principal immediately as long as a minimum credit enhancement level is maintained. Additionally, unlike PL mezzanine classes, which lose subordination over time due to scheduled principal payments to more junior classes, the M-2 and B-H classes will not receive any scheduled or unscheduled allocations until the M-1 is paid in full. The B-H class will not receive any scheduled or unscheduled principal allocations until the M-2 is paid in full.
10-Year Hard Bullet Maturity: The M-1 and M-2 notes benefit from a 10-year legal final maturity. As a result, any collateral losses on the reference pool that occur beyond year 10 are borne by Fannie Mae and do not impact the transaction. Fitch accounted for the 10-year hard bullet window in its default analysis and applied a 10% reduction to its lifetime default expectations.
Rep and Warranty Gaps: While the loan defect risk for 2013-C01 is notably lower than for agency and non-agency mortgage pools securitized prior to 2009, Fitch believes the risk is greater for this transaction than for recently issued U.S. PL RMBS. Notably, neither Fannie Mae nor an independent third party will conduct loan file reviews for credit events, and Fannie Mae will not conduct any reviews of loans from a seller once it has filed for bankruptcy. Fitch incorporated this risk into its analysis by treating all historical repurchases as if they were defaulted loans that were not repurchased. Consequently, the rating analysis includes an assumption that the loans will experience defect rates consistent with historical rates and that those defects will not be repurchased.
Solid Alignment of Interests: While the transaction is designed to transfer credit risk to private investors, Fitch believes the transaction benefits from solid alignment of interests. Fannie Mae will be retaining credit risk in the transaction by holding the senior reference tranche A-H, which has 3% of loss protection, as well as the first loss B-H reference tranche, sized at 30bps. Fannie is also retaining an 11% vertical slice/interest in the M-1 and M-2 notes.
Limited Size and Scope of Third-Party Diligence: Only 608 loans in the reference pool were selected for review by a third-party diligence provider. This sample selection was also limited to a population of 1,917 loans that had been previously reviewed by Fannie Mae. Furthermore, third-party due diligence findings noted 907 compliance findings, which were waived by Fannie Mae due to its limited post-close loan quality review for compliance. These concerns are mitigated by Fitch's review of Fannie Mae's risk management and quality control process/infrastructure, which has been significantly improved over the past several years.
Special Hazard Leakage: Fitch believes the structure is vulnerable to special hazard risk as there is no consideration for payment disruptions related to natural disaster events in the 'credit event' definition. As such, credit protection in the transaction may be eroded by natural disasters that may cause extended delinquencies (that may in part be allowed by disaster relief programs) but where borrowers ultimately cure. Fitch considered this risk in its analysis and conducted sensitivity analysis and found, based on prior observed performance in post-natural disaster events including Hurricane Katrina and the Northridge earthquake, the risk exposure is relatively low.
Receivership Risk Considered: Under the Federal Housing Finance Regulatory Reform Act, the Federal Housing Finance Agency (FHFA) must place Fannie Mae into receivership if it determines that Fannie Mae's assets are less than its obligations for longer than 60 days following the deadline of its SEC filing, as well as for other reasons. As receiver, FHFA could repudiate any contract entered into by Fannie Mae if it is determined that it would promote an orderly administration of Fannie Mae's affairs. Fitch believes that the U.S. government will continue to support Fannie Mae, as reflected in its current rating of Fannie Mae. However, if at some point Fitch views the support as being reduced and receivership likely, the ratings of Fannie Mae could be downgraded and the M-1 notes rating affected.
Fitch's analysis incorporates a sensitivity analysis to demonstrate how the ratings would react to steeper market value declines (MVDs) than assumed at the state or MSA level. The implied rating sensitivities are only an indication of some of the potential outcomes and do not consider other risk factors that the transaction may become exposed to or be considered in the surveillance of the transaction. Two sets of sensitivity analyses were conducted at the state and national level to assess the effect of higher MVDs for the subject pool.
Historical Economic Data Incorporated in sMVD Projections: In its analysis, Fitch considered placing a greater emphasis on recent economic performance in determining MVDs for the pool. While Fitch's current loan loss model looks to three years of historical data and one year of projections, this does not incorporate recent notable economic improvement. To reflect the more recent economic environment, a sensitivity analysis was performed using two years historical economic data and two years of projections.
California sMVDs: Roughly 27% of the pool is located in California, in areas with both high and low MVD projections. The MVD projections are key contributors to Fitch's default assessment of this pool. Fitch conducted sensitivity analysis assuming sMVDs were 5%, 10%, and 15% higher than that for California. The sensitivity analysis indicated an impact on ratings for the rated bond.
Additional Decline in sMVD at the National Level: This set of sensitivity analysis demonstrates how the rating would react to steeper MVDs at the national level. The analysis assumes MVDs of 5%, 10% and 15% in addition to the model-projected 29.8% for this pool. The analysis indicates a rating impact with a further 5% MVD from the current model projection with further rating migration for the additional 10% and 15% MVD assumptions.
Key Rating Drivers and Rating Sensitivities are further detailed in Fitch's accompanying presale report, available at 'www.fitchratings.com' or by clicking on the above link.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research
--'U.S. RMBS Mortgage Loan Loss Model Criteria' (August 2013);
--'U.S. RMBS Originator Review and Third-Party Due Diligence Criteria' (April 2013);
--'U.S. RMBS Cash Flow Analysis Criteria' (April 2013);
--'U.S. RMBS Representations and Warranties Criteria' (June 2013);
-- 'U.S. RMBS Rating Criteria' (July 2013)
--'Global Structured Finance Rating Criteria'(May 2013)
--'Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes' (February 2013).
--'Connecticut Avenue Securities Series 2013-C01 Representations and Warranties Presale Appendix' (Oct 2013)
Applicable Criteria and Related Research: Connecticut Avenue Securities Series 2013-C01 (US RMBS)
U.S. RMBS Representations and Warranties Criteria
Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes
Global Structured Finance Rating Criteria
U.S. RMBS Rating Criteria
U.S. RMBS Loan Loss Model Criteria
U.S. RMBS Originator Review and Third-Party Due Diligence Criteria
U.S. RMBS Cash Flow Analysis Criteria