NEW YORK--(BUSINESS WIRE)--Fitch Ratings expects to assign the following ratings and Rating Outlooks to Freddie Mac's risk-transfer transaction, Structured Agency Credit Risk debt notes series 2015-HQ2 (STACR 2015-HQ2):
--$114,000,000 class M-1 notes 'Asf'; Outlook Stable;
--$114,000,000 class M-1F exchangeable notes 'Asf'; Outlook Stable;
--$114,000,000 class M-1I notional exchangeable notes 'Asf'; Outlook Stable;
--$140,600,000 class M-2 notes 'BBBsf'; Outlook Stable;
--$140,600,000 class M-2F exchangeable notes 'BBBsf'; Outlook Stable;
--$140,600,000 class M-2I notional exchangeable notes 'BBBsf'; Outlook Stable;
--$95,000,000 class M-3 notes 'BBsf'; Outlook Stable;
--$95,000,000 class M-3F exchangeable notes 'BBsf'; Outlook Stable;
--$95,000,000 class M-3I notional exchangeable notes 'BBsf'; Outlook Stable;
--$254,600,000 class M-12 exchangeable notes 'BBBsf'; Outlook Stable;
--$349,600,000 class MA exchangeable notes 'BBsf'; Outlook Stable.
The following classes will not be rated by Fitch:
--$28,626,566,893 class A-H reference tranche;
--$340,871,296 class M-1H reference tranche;
--$420,407,931 class M-2H reference tranche;
--$284,059,414 class M-3H reference tranche;
--$76,000,000 class B notes;
--$227,247,530 class B-H reference tranche.
The 'Asf' rating for the M-1 notes reflects the 4.10% subordination provided by the 1.85% class M-2 notes, the 1.25% class M-3 notes and the 1.00% class B notes. The 'BBBsf' rating for the M-2 notes reflects the 2.25% subordination provided by the 1.25% class M-3 notes and the 1.00% class B notes. The notes are general unsecured obligations of Freddie Mac (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 Freddie Mac-guaranteed MBS.
STACR 2015-HQ2 is Freddie Mac's twelfth 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 $30.3 billion pool of mortgage loans currently held in previously issued MBS guaranteed by Freddie Mac 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, 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, M-12, M-3, M-3F and M-3I 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, M-2, M-3 and B 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 pool consists of 137,280 prime-quality mortgages totaling $30.32 billion with loan to value ratios (LTVs) greater than 80% but less than and equal to 95%, which were acquired by Freddie Mac in the first three quarters of 2013. The weighted average (WA) combined LTV (CLTV) ratio, debt-to-income (DTI) ratio, and credit score are 91.6%, 33.1%, and 757, respectively. All loans were underwritten with full documentation and the pool is seasoned 23 months.
Improved Geographic Distribution: The reference pool is a subset of the reference pool used in the STACR 2014-HQ2 transaction as it excludes loans that have paid off or fell delinquent since issuance. The removal of the approximately 10,000 loans redistributed the geographic concentration to areas with lower projected sustainable market value declines (sMVDs). As a result, the sustainable LTV (sLTV) decreased to 84.2% from 85.7%. There are also fewer loans with sLTVs greater than 90.0% at 14.9% compared to 22.4%.
Solid Lender Review and Acquisition Processes: Fitch found that Freddie Mac has a well-established and disciplined process in place to purchase 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 acquisitions. Fitch accounted for the lower risk by applying a 10% reduction to the reference pool's lifetime default expectations.
10-Year Hard Maturity: M-1, M-2, M-3, and B 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 reduction to its lifetime default expectations. The credit ranged from 8% at the 'Asf' rating category to 12% at the 'BBsf' rating category.
Few Findings in Third-Party Diligence: Third-party due diligence review was performed by Clayton Holdings LLC (Clayton) on the reference pool as part of the STACR 2014-HQ2 transaction. No additional review was performed for this transaction as no loans were added to the reference pool. 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.
Fixed Loss Severity: The transaction's fixed 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 with 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 classes will not receive any scheduled or unscheduled principal allocations until the M-1 class is paid in full. The B class will not receive any scheduled or unscheduled principal allocations until the M-3 class is paid in full.
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 5.60% of loss protection, as well as a minimum of 50% of the first-loss B tranche, sized at 100 bps. Initially, Freddie Mac will retain an approximately 75% vertical slice/interest in the M-1, M-2, and M-3 tranches.
Special Hazard Risk Mitigated: Freddie Mac introduced an 18-month grace period for delinquent borrowers who experience a natural disaster and are placed in a forbearance plan by the servicer, starting from the STACR 2014-DN3/HQ1 transactions. 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, but possibly after 180 days of delinquency.
Seller Insolvency Risk Addressed: Freddie Mac will conduct quality control (QC) reviews on 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 it considers a full framework.
Receivership Risk Considered: Under the Federal Housing Finance Regulatory Reform Act, U.S. Federal Housing Finance Agency (FHFA) must place Freddie Mac into receivership if it determines that Freddie Mac's assets are less than its obligations for longer than 60 days following its SEC filing deadline. 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, which is reflected in its current rating of the government-sponsored enterprise (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 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 MVDs at the national level. The analysis assumes MVDs of 10%, 20%, and 30%, in addition to the model projected 28.0% at the 'Asf' level, 23.2% at the 'BBBsf' level and 18.4% at the 'BBsf' 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 10%, 21% and 47% would potentially move the 'Asf' 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.
DUE DILIGENCE USAGE
Fitch was provided with due diligence information from Clayton Holdings LLC (Clayton). Third-party due diligence review was performed by Clayton on the reference pool as part of the STACR 2014-HQ2 transaction. No additional review was performed for this transaction as no loans were added to the reference pool.
The due diligence focused on credit and compliance reviews, desktop valuation reviews and data integrity. Clayton examined selected loan files with respect to the presence or absence of relevant documents. Fitch received certifications indicating that the loan-level due diligence was conducted in accordance with Fitch's published standards. The certifications also stated that the company performed its work in accordance with the independence standards, per Fitch's criteria, and that the due diligence analysts performing the review met Fitch's criteria of minimum years of experience. Fitch considered this information in its analysis and the findings did not have an impact on our analysis.
Additional information is available at www.fitchratings.com.
Structured Agency Credit Risk Debt Notes, Series 2015-HQ2 (US RMBS)
Counterparty Criteria for Structured Finance and Covered Bonds (pub. 14 May 2014)
Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes (pub. 09 Mar 2015)
Global Structured Finance Rating Criteria (pub. 31 Mar 2015)
Rating Criteria for U.S. Residential and Small Balance Commercial Mortgage Servicers (pub. 23 Apr 2015)
U.S. RMBS Cash Flow Analysis Criteria (pub. 06 Apr 2015)
U.S. RMBS Loan Loss Model Criteria (pub. 17 Nov 2014)
U.S. RMBS Master Rating Criteria (pub. 01 Jul 2014)
U.S. RMBS Surveillance and Re-REMIC Criteria (pub. 24 Jun 2014)