NEW YORK--(BUSINESS WIRE)--Fitch Ratings expects to assign the following ratings and Rating Outlooks to Fannie Mae's third risk-transfer transaction, Connecticut Avenue Securities, series 2014-C02:
--$555,575,000 class 1M-1 notes 'BBB-sf'; Outlook Stable.
--$174,204,000 class 2M-1 notes 'BBB+sf'; Outlook Stable.
The following classes will not be rated by Fitch:
--$ 45,438,021,034 class 1A-H reference tranche;
--$ 29,966,508 class 1M-1H reference tranche;
--$ 644,467,000 class 1M-2 notes;
--$ 34,761,149 class 1M-2H reference tranche;
--$ 140,529,962 class 1B-H reference tranche;
--$ 13,451,089,663 class 2A-H reference tranche;
--$ 14,460,634 class 2M-1H reference tranche;
--$ 225,820,000 class 2M-2 notes;
--$ 18,745,267 class 2M-2H reference tranche;
--$ 90,838,528 class 2B-H reference tranche.
The 'BBB-sf' rating for the 1M-1 notes reflects the 1.75% subordination provided by the 1.45% class 1M-2 notes and the non-offered 0.30% 1B-H reference tranche. The 'BBB+sf' rating for the 2M-1 notes reflects the 2.40% subordination provided by the 1.75% class 2M-2 notes and the non-offered 0.65% 2B-H reference tranche. The notes are general senior unsecured obligations of Fannie Mae (rated 'AAA'; Outlook Stable 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.
The reference pool of mortgages will be divided into two loan groups. Group 1 will consist of mortgage loans with loan-to-values (LTVs) of less than or equal to 80% while group 2 will consist of mortgage loans with LTVs greater than 80% and less than or equal to 97%. Each loan group has its own loss severity schedule and issued notes. There will be no cross-collateralization. Aside from distinct loss severity schedules, each group's structure will be identical.
Connecticut Avenue Securities, series 2014-C02 (CAS 2014-C02) is Fannie Mae's third 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.
The objective of the transaction is to transfer credit risk from Fannie Mae to private investors with respect to a $61 billion pool of mortgage loans currently held in previously issued MBS guaranteed by Fannie Mae where principal repayment of the notes is 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 1M-1 and 2M-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 1M-1 and 2M-1 notes will be issued as uncapped LIBOR-based floaters and will carry a 10-year legal final maturity.
KEY RATING DRIVERS
Inclusion of Higher Loan-to-Value Loans: Fannie Mae has expanded its eligibility criteria to include loans with original LTV's of up to 97%. These loans have been included in this transaction as Group 2. All higher LTV loans were subject to the same underwriting, quality control and servicing practices as those loans with original LTV's below 80%. Fitch's analysis of these loans resulted in a Probability of Default (PD) that was approximately 1.4x higher than the lower LTV loans.
Enhanced Quality Control Process: Starting with the 2013 acquisitions, Fannie Mae implemented further enhancements to its performing loan quality control (QC) framework, which Fitch found to be robust and should reduce the risk of credit events arising from faulty loan origination practices and sunset provisions. Fitch believes that Fannie Mae is an above average aggregator for 2013 acquisitions. As a result, Fitch applied a reduction to its default expectations to account for the lower risk associated with the recent acquisitions.
Market Value Decline Sensitivity: Fitch considered further market value decline (MVD) sensitivities, in addition to those generated by its sustainable home price (SHP) model. These scenarios aligned Fitch's 'Asf' sustainable MVD assumptions with peak-to-trough MVDs experienced during the housing crisis through 2009. The sensitivity analysis, which was factored into Fitch's loss expectations, resulted in applying a sustainable MVD (sMVD) of 14% from 16% for Group 1 and an sMVD of 10% from 11% for Group 2.
Few Due Diligence Findings: The due diligence review resulted in minimal findings. The findings are reflective of the improvements made to Fannie Mae's risk management and QC processes, which have evolved over time, with the majority of the processes developed following the crisis and implemented prior to 2013. The findings also reflect the scope of the due diligence review to better indicate Fannie Mae's QC process.
Fixed Loss Severity: One of the unique structural features of the transaction is a fixed loss severity (LS) schedule tied to cumulative net credit events. If actual loan LS is above the set schedule, Fannie Mae absorbs the higher losses. Fitch views the fixed LS positively, as it reduces the uncertainty that may arise due to future changes in Fannie Mae's loss mitigation or loan modification policies. The fixed severity also offers investors greater protection against natural disaster events where properties are severely damaged, as well as in cases of limited or no recourse to insurance.
Advantageous Payment Priority: The payment priority of M-1 notes will result in a shorter life and more stable CE 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 notes can receive a full pro-rata share of unscheduled principal immediately, as long as a minimum CE 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 in each group will not receive any scheduled or unscheduled allocations until the M-1 class is paid in full. The B-H classes will not receive any scheduled or unscheduled principal allocations until the M-2 class is paid in full.
10-Year Hard Maturity: The 1M-1, 1M-2, 2M-1 and 2M-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 affect the transaction. Fitch accounted for the 10-year hard maturity in its default analysis and applied a 10% reduction to its lifetime default expectations.
Rep and Warranty Gaps: While the loan defect risk for 2014-C02 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.
Rep and Warranty Sunsets: All the loans were acquired by Fannie Mae in 1Q13, which qualifies them for the new rep and warranty framework adopted by Fannie Mae through its regulator, the U.S. Federal Housing Finance Agency (FHFA), for conventional loans sold or delivered after Jan. 1, 2013. Under the new framework, lenders will be provided repurchase relief from underwriting breaches for loans that had made 36 consecutive on-time payments or those with no more than two 30-day delinquencies and no 60-day or greater delinquencies current on the 60th month. In conjunction with this change, Fannie Mae enhanced its performing loan QC process and instituted incentives for lenders to maintain high-quality loan standards.
Solid Alignment of Interests: While the transaction is designed to transfer credit risk to private investors, Fitch believes the transaction benefits from a solid alignment of interests. Fannie Mae will be retaining credit risk in the transaction by holding the A-H senior reference tranches, which have a loss protection of 3% in Group 1 and 3.75% in Group 2, as well as the first loss B-H reference tranche, sized at 30 bps and 65 bps, respectively. Fannie Mae is also retaining a 5.2% vertical slice/interest in the M-1 and M-2 tranches for Group 1 and 7.75% for Group 2.
Limited Size/Scope of Third-Party Diligence: Only 608 loans of those eligible to be included in the reference pool were selected for a full review (credit, property valuation and compliance) by a third-party diligence provider. Of the 608 loans, 459 were part of this transaction's reference pool (347 in Group 1 and 112 in Group 2). An additional 608 loans were selected for a property-valuation-only review. Of this population, 472 were part of this transaction's reference pool (356 in Group 1 and 116 in Group 2). The sample selection was limited to a population of 5,572 loans that were previously reviewed by Fannie Mae and met the reference pool's eligibility criteria. Furthermore, the third-party due diligence scope was limited to reflect Fannie Mae's post-close loan review for compliance. Fitch's review of Fannie Mae's risk management and QC process/infrastructure, which has been significantly improved over the past several years, indicates a robust control environment that should minimize loan quality risk.
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 (which may, in part, be allowed by disaster relief programs) but of which borrowers ultimately cure. Fitch considered this risk in its analysis, conducted sensitivity analysis and found, based on prior observed performance in post-natural disaster events (including Hurricane Katrina and the Northridge Earthquake), that the risk exposure is relatively low.
Receivership Risk Considered: Under the Federal Housing Finance Regulatory Reform Act, FHFA must place Fannie Mae into receivership if it determines that Fannie Mae's assets are less than its obligations for more 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 the termination of such contract would promote an orderly administration of Fannie Mae's affairs. Fitch believes that the U.S. government will continue to support Fannie Mae, which is 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' ratings affected.
Fitch's analysis incorporates sensitivity analyses to demonstrate how the ratings would react to steeper market value declines (MVDs) than assumed at both the MSA and national levels. 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.
This defined stress sensitivity analysis demonstrates how the ratings would react to steeper market value declines at the national level. The analysis assumes market value declines of 10%, 20%, and 30%, in addition to the model projected 31% and 27% for group 1 and group 2, respectively. The analysis indicates that there is some potential rating migration with higher MVDs, compared with the model projection.
Fitch also conducted defined rating sensitivities which determine the stresses to MVDs that would reduce a rating by one full category, to non-investment grade, and to 'CCCsf'. For example, additional MVD of 9% would potentially reduce the rated class 1M-1 and 2M-1 down one rating category.
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 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 2014);
--'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 2014);
--'Connecticut Avenue Securities Series 2014-C02 Representations and Warranties Presale Appendix' (May 2014).
Applicable Criteria and Related Research: Connecticut Avenue Securities, Series 2014-C02 (US RMBS)
U.S. RMBS Loan Loss Model 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 Representations and Warranties Criteria
U.S. RMBS Cash Flow Analysis Criteria
U.S. RMBS Originator Review and Third-Party Due Diligence Criteria