NEW YORK--(BUSINESS WIRE)--Fitch Ratings expects to assign the following ratings and Rating Outlooks to Freddie Mac's fifth risk transfer transaction:
Structured Agency Credit Risk Debt Notes Series 2014-DN3 (STACR 2014-DN3):
--$160,000,000 class M-1 notes 'A-sf'; Outlook Stable;
--$160,000,000 class M-1F exchangeable notes 'A-sf'; Outlook Stable;
--$160,000,000 class M-1I notional exchangeable notes 'A-sf'; Outlook Stable;
--$192,000,000 class M-2 notes 'BBB-sf'; Outlook Stable;
--$192,000,000 class M-2F exchangeable notes 'BBB-sf'; Outlook Stable;
--$192,000,000 class M-2I notional exchangeable notes 'BBB-sf'; Outlook Stable;
--$352,000,000 class M-12 exchangeable notes 'BBB-sf'; Outlook Stable.
The following classes will not be rated by Fitch:
--$18,837,906,460 class A-H reference tranche;
--$37,462,332 class M-1H reference tranche;
--$44,954,798 class M-2H reference tranche;
--$320,000,000 class M-3 notes;
--$320,000,000 class M-3F exchangeable notes;
--$320,000,000 class M-3I notional exchangeable notes;
--$74,924,664 class M-3H reference tranche;
--$78,984,933 class B-H reference tranche;
--$672,000 class MA exchangeable notes.
The 'A-sf' rating for the M-1 notes reflects the 3.60% subordination provided by the 1.20% class M-2 notes, the 2.00% class M-3 notes and the non-offered 0.40% B-H reference tranche. The 'BBB-sf' rating for the M-2 notes reflects the 2.40% subordination provided by the 2.00% class M-3 notes and the non-offered 0.40% B-H reference tranche. The notes are general unsecured obligations of Freddie Mac (rated 'AAA'/Rating Outlook Stable by Fitch) subject to the credit and principal payment risk of a pool of certain residential mortgage loans held in various Freddie Mac-guaranteed MBS.
STACR 2014-DN3 is Freddie Mac's fifth 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 Freddie Mac to private investors with respect to a $19.75 billion pool of mortgage loans currently held in previously issued MBS guaranteed by Freddie Mac where principal repayment of the notes are subject to the performance of a reference pool of mortgage loans. As loans become 180 day 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, Freddie Mac will be responsible for making monthly payments of interest and principal to investors. Because of the counterparty dependence on Freddie Mac, Fitch's expected rating on the M-1, M-1F, M-1I, M-2, M-2F, M-2I and M-12 notes will be based on the lower of: the quality of the mortgage loan reference pool and credit enhancement available through subordination; and Freddie Mac's issuer default rating. The M-1 and M-2 notes will be issued as uncapped LIBOR-based floaters and will carry a 10-year legal final maturity.
KEY RATING DRIVERS
Special Hazard Risk Mitigated: Freddie Mac introduced an 18-month grace period for delinquent borrowers who experience a natural disaster and are put on a forbearance plan by the servicer. Fitch views this enhancement positively, as it reduces the risk of eroding credit protection for temporary borrower delinquencies arising from natural disasters that typically cure.
Seller Insolvency Risk Addressed: An additional positive enhancement includes an expansion of quality control (QC) reviews to all loans that experience a credit event, irrespective of the seller's insolvency, as long as the rep and warranty period has not sunset. Effective June 2, 2014, all loans for which the rep and warranty is in effect will be subject to a review to determine whether an underwriting defect has taken place. Fitch believes that this provision more closely aligns the deal's rep enforcement mechanism with what Fitch considers to be a full framework.
Prime-Quality Mortgage Reference Pool: The reference mortgage loan pool consists of 87,222 prime-quality mortgages totaling $19.75 billion acquired by Freddie Mac in the fourth quarter of 2013 (4Q'13). The weighted average (WA) combined loan-to-value (CLTV), debt-to-income (DTI) and credit scores are 76.7%, 34.6% and 755, respectively. All loans were underwritten with full documentation. The reference pool also benefits from significant geographic diversity, with the largest metropolitan statistical area (MSA) accounting for 8.1%.
Market Value Decline Sensitivity: Fitch considered additional market value decline (MVD) sensitivities to those generated by its sustainable home price (SHP) model. These scenarios aligned Fitch's 'Asf' sustainable MVD (sMVD) 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 sMVD of 12% from 14%.
Solid Lender Review and Acquisition Processes: Fitch found that Freddie Mac has a well-established and disciplined process in place for the purchase of loans and views its lender-approval and oversight processes for minimizing counterparty risk and ensuring sound loan quality acquisitions as positive. Loan QC review processes are thorough and indicate a tight control environment that limits origination risk. Fitch has determined Freddie Mac to be an above-average aggregator for its 2013 and later product. The lower risk was accounted for by Fitch by applying a lower default estimate for the reference pool.
Few Findings in Third-Party Diligence: While only 850 loans were selected for review by a third-party diligence provider, the results indicated limited findings or were deemed as nonmaterial by Fitch. The overall results reflect Freddie Mac's tight control over the documentation and loan delivery process.
Eminent Domain Risk Mitigated: The STACR Series 2014-DN3 transaction includes a provision that protects investors against eminent domain risk. Loans will be removed from the reference pool if they are seized pursuant to any special eminent domain proceeding brought by any federal, state or local government.
Fixed Loss Severity: The transaction's fixed loss severity (LS) schedule tied to cumulative net credit events is a positive feature, as it reduces uncertainty that may be driven by future changes in Freddie Mac's loss mitigation or loan modification policies and offers investors greater protection against natural disaster events, where properties are severely damaged and there is limited or no recourse to insurance. If the actual loan LS is above the set schedule, Freddie Mac absorbs the higher losses.
Advantageous Payment Priority: The payment priority of the M-1 class 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 class can receive a full pro-rata share of unscheduled principal immediately, as long as a minimum CE level is maintained and the net cumulative credit event is within a certain threshold. Additionally, unlike PL mezzanine classes, which lose subordination over time due to scheduled principal payments to more junior classes, the M-2, M-3 and B-H classes will not receive any scheduled or unscheduled principal allocations until the M-1 class is paid in full. The B-H class will not receive any scheduled or unscheduled principal allocations until the M-3 class is paid in full.
10-Year Hard Maturity: M-1, M-2 and M-3 notes benefit from a 10-year legal final maturity. As a result, any credit events on the reference pool that occur beyond year 10 are borne by Freddie Mac and do not affect the transaction. Fitch accounted for the 10-year hard maturity window in its default analysis and applied a 10% reduction to its lifetime default expectations.
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. Freddie Mac will retain credit risk in the transaction by holding the senior reference tranche A-H, which has 4.6% of loss protection, as well as the first-loss B-H reference tranche, sized at 40 basis points (bps). Initially, Freddie Mac will retain a 19% vertical slice/interest in the M-1, M-2 and M-3 tranches, but may re-insure at the most 14% in the future.
Receivership Risk Considered: Under the Federal Housing Finance Regulatory Reform Act, FHFA must place Freddie Mac into receivership if it determines that the GSEs assets are less than its obligations for longer than 60 days following the deadline of its SEC filing. As receiver, FHFA could repudiate any contract entered into by Freddie Mac if it is determined that such action would promote an orderly administration of Freddie Mac's affairs. Fitch believes that the U.S. government will continue to support Freddie Mac, as reflected in its current rating of the GSE. However, if at some point Fitch views the support as being reduced and receivership likely, the rating of Freddie Mac could be downgraded and ratings on M-1 and M-2 notes, along with their corresponding MAC notes, could be 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 metropolitan statistical area (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 34% at the 'A-sf' level and 30% at the 'BBB-sf' level. 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 MVDs of 8%, 13% and 31% would potentially reduce the 'A-sf' rated class down one rating category, to non-investment grade, and to 'CCCsf', respectively.
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
--'Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes' (February 2014);
--'Global Structured Finance Rating Criteria' (May 2014);
--'Counterparty Criteria for Structured Finance and Covered Bonds' (May 2014);
--'U.S. RMBS Master Rating Criteria' (July 2014);
--'U.S. RMBS Loan Loss Model Criteria' (December 2013);
--'U.S. RMBS Cash Flow Analysis Criteria' (April 2014);
--'Rating Criteria for U.S. Residential and Small Balance Commercial Mortgage Servicers' (January 2014);
--'U.S. RMBS Surveillance and Re-Remic Criteria' (June 2014);
--'Structured Agency Credit Risk Debt Notes, Series 2014-DN3 Representations and Warranties Presale Appendix' (August 2014).
Applicable Criteria and Related Research: Structured Agency Credit Risk Debt Notes, Series 2014-DN3 (US RMBS)
Rating Criteria for US Residential and Small Balance Commercial Mortgage Servicers
U.S. RMBS Surveillance and Re-REMIC Criteria
Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes
Global Structured Finance Rating Criteria - Effective from 20 May 2014 to 4 August 2014
Counterparty Criteria for Structured Finance and Covered Bonds
U.S. RMBS Master Rating Criteria
U.S. RMBS Loan Loss Model Criteria
U.S. RMBS Cash Flow Analysis Criteria