Fitch Ratings expects to rate COLT 2016-3 Mortgage Loan Trust (COLT 2016-3) as follows:
--$129,916,000 class A-1 certificates 'AAAsf'; Outlook Stable;
--$26,751,000 class A-2 certificates 'AAsf'; Outlook Stable;
--$37,135,000 class A-3 certificates 'Asf'; Outlook Stable;
--$9,820,000 class M-1 certificates 'BBBsf'; Outlook Stable;
--$7,224,000 class B-1 certificates 'BBsf'; Outlook Stable;
--$7,111,000 class B-2 certificates 'Bsf'; Outlook Stable.
Fitch will not be rating the following certificates:
--$7,788,589 class B-3 certificates.
This is the third Fitch-rated RMBS transaction issued post-crisis that consists primarily of newly originated, non-prime mortgage loans.
This is the first COLT transaction with a 'AAAsf' rating. Over the past year, Fitch has become more comfortable with the operational risk of the issuer through extensive due diligence results, multiple on-site visits and early performance trends. The rating also reflects the significant initial credit enhancement and modified sequential payment priority.
The most notable collateral difference between COLT 2016-3 and COLT 2016-2 (which closed September 2016) is a further increase in the percentage of loans that are not originated by Caliber Home Loans, Inc. (Caliber) and that were originated to a bank statement program. Caliber originated just over 70% of the loans with the remaining split between Sterling Bank and Trust, FSB (Sterling) at about 22% and Lendsure Mortgage Corp. (Lendsure) at almost 7%.
From a structural perspective, this transaction has a more conservative cumulative loss trigger than 2016-2 which redirects all principal to the most senior bond under Fitch's stresses faster than in the prior deals, and makes payments to the bonds from total available funds.
Fitch also introduced a favorable change in the model treatment for the mortgage pool that adjusts default probability based on the relationship of the loan's property value to the area's median property value. This is a variable that is already incorporated into the Prime model but this is the first time it has been used in the Alt-A model. The rating committee applied the adjustment due to the relatively high property values of the assets. The average property value of the assets in this pool is larger than the average property value in the legacy Prime historical dataset.
The transaction is collateralized with 62% non-QM mortgages as defined by the ATR rule while 31% is designated as HPQM and the remainder either meets the criteria for Safe Harbor QM or ATR does not apply.
The certificates are supported by a pool of 474 mortgage loans with credit scores (712) similar to legacy Alt-A collateral. However, unlike legacy originations, many of the loans were underwritten to comprehensive Appendix Q documentation standards and 100% due diligence was performed confirming adherence to the guidelines. The weighted average loan-to value ratio is roughly 73% and many of the borrowers have significant liquid reserves. The transaction also benefits from an alignment of interest as LSRMF Acquisitions I, LLC (LSRMF) or a majority owned affiliate, will be retaining a horizontal interest in the transaction equal to not less than 5% of the aggregate fair market value of all the certificates in the transaction.
Fitch applied a default penalty to 39% of the pool to account for borrowers with a mortgage derogatory as recent as two years prior to obtaining the new mortgage and increased its non-QM loss severity penalty on lower credit quality loans to account for potentially greater number of challenges to the ATR Rule. Fitch also increased default expectations by 358 basis points at the 'AAAsf' rating category to reflect variances from a full representation and warranty (R&W) framework.
Initial credit enhancement for the class A-1 certificates of 42.45% is substantially above Fitch's 'AAAsf' rating stress loss of 24.75%. The additional initial credit enhancement is primarily driven by the pro rata principal distribution between the A-1, A-2 and A-3 certificates, which will result in a significant reduction of the class A-1 subordination over time through principal payments to the A-2 and A-3.
KEY RATING DRIVERS
Non-Prime Credit Quality (concern): The pool's weighted average credit score of 712 is lower than the weighted average credit score of 736 for legacy Prime loans. The pool was analyzed using Fitch's Alt-A legacy model with positive adjustments made to account for the improved operational quality for recent originations, due diligence review, larger property-values and presence of liquid reserves. Negative adjustments were made to reflect the inclusion of borrowers (39%) with recent credit events, increased risk of ATR challenges and loans with TILA RESPA Integrated Disclosure (TRID) exceptions.
Bank Statement Loans Included (concern): 112 of the non-QM loans included in this pool were underwritten to a bank statement program in accordance with either Sterling's or Lendsure's guidelines, where a one-month or 12-month (respectively) bank statement was used to verify income, which is not consistent with Appendix Q standards and Fitch's view of a full documentation program. While employment and assets are fully verified, the limited income verification resulted in application of a probability of default (PD) penalty of approximately 1.4x for the bank statement loans. Additionally, the assumed probability of ATR claims was doubled.
Operational and Data Quality (positive): Fitch reviewed Caliber's, Sterling's, Lendsure's, and Hudson's origination and acquisition platforms and found them to have sound underwriting and operational control environments, reflecting industry improvements following the financial crisis that are expected to reduce risk related to misrepresentation and data quality. All loans in the mortgage pool were reviewed by a third-party due diligence firm and the results indicated strong underwriting and property valuation controls.
Alignment of Interests (positive): The transaction benefits from an alignment of interests between the issuer and investors. LSRMF Acquisition I, LLC (LSRMF), as sponsor and securitizer, or an affiliate will retain a horizontal interest in the transaction equal to not less than 5% of the aggregate fair market value of all certificates in the transaction. As part of its focus on investing in residential mortgage credit, as of the closing date, LSRMF or an affiliate, will retain the class B2, B3 and X certificates, which represent 6.60% of the transaction. Lastly, for the 347 Caliber-originated loans, the representations and warranties are provided by Caliber, which is owned by LSRMF affiliates and therefore, also aligns the interest of the investors with those of LSRMF to maintain high quality origination standards and sound performance, as Caliber will be obligated to repurchase loans due to rep breaches.
Modified Sequential Payment Structure (mixed): The structure distributes collected principal pro rata among the class A notes while shutting out the subordinate bonds from principal until both classes have been reduced to zero. To the extent that either the cumulative loss trigger event or the credit enhancement trigger event occurs in a given period, principal will be distributed sequentially to the class A1, A2, and A3 bonds until they are reduced to zero. The loss and credit enhancement triggers for this transaction are tighter than in previous COLT deals, which provide for 100% redirection of principal to class A-1 should losses as a percentage of the cut-off date balance exceed certain thresholds.
R&W Framework (concern): As originators Caliber, Lendsure, and Sterling will be providing loan-level representations and warranties to the trust. While the reps for this transaction are substantively consistent with those listed in Fitch's published criteria and provide a solid alignment of interest, Fitch added 358 bps to the projected defaults at the 'AAAsf' rating category to reflect the non-investment-grade counterparty risk of the providers and the lack of an automatic review of defaulted loans. The lack of an automatic review is mitigated by the ability of holders of 25% of the total outstanding aggregate class balance to initiate a review.
Performance Triggers (mixed): Credit enhancement and loan loss triggers convert principal distribution to a straight sequential payment priority in the event of poor asset performance. The loss triggers in 2016-3 are relatively low (notably lower than 2016-2), which benefits the most senior classes. The COLT transactions do not incorporate a delinquency trigger, which increases the risk that a delay in loan liquidations will allow performance triggers to pass longer than they would otherwise. The initial credit enhancement of the A-1 class considers a back-loaded loss timing assumption consistent with delayed losses. Also, the risk is mitigated by a lock-out of all principal distribution to the M-1 class and below until the more senior classes are paid in full, regardless of performance trigger status.
Servicing and Master Servicer (positive): Servicing will be performed on 78% of the loans by Caliber and on 22% of the loans by Sterling. Fitch rates Caliber 'RPS2-' with a Negative Rating Outlook due to its fast-growing portfolio and regulatory scrutiny and reviewed Sterling to be acceptable. Wells Fargo Bank, N.A. (Wells Fargo), rated 'RMS1' with a Stable Outlook, will act as master servicer and securities administrator. Advances required but not paid by Caliber and Sterling will be paid by Wells Fargo.
A variation was made to Fitch's 'U.S. RMBS Loan Loss Model Criteria' in regards to treatment of loans with prior credit events. Historical data suggests that borrowers with similar credit scores as those in the pool are nearly 20% more likely to default on a future mortgage, as compared to all outstanding borrowers, if they had a prior mortgage related credit event. This adjustment was applied to the roughly 39% of the pool that had a prior mortgage related credit event, resulting in approximately an 8% increase to the pool's probability of default at each rating category.
Due to the structural features of the transaction, Fitch analyzed the collateral with a customized version of one of its loss models. Fitch's Alt-A Loan Loss Model was altered to include three additional inputs; due diligence percentage, operational quality and liquid reserves. These variables were not common in legacy Alt-A loans and were excluded in the derivation of Fitch's Alt-A model. Given the improvement in today's underwriting over legacy standards, these aspects were taken into consideration and a net credit was applied to the pool.
A final variation was made as an outside of the model adjustment to account for the higher than average property values of the mortgage loans and its impact on the probability of default. Fitch's analysis showed that loans associated with property values significantly below the median exhibited higher default rates relative to those at or above the median value and larger properties are generally associated with higher income borrowers who may be less sensitive to income shocks than lower income borrowers. Less desirable, low-value properties may also increase the default risk if the borrower has more difficulty selling the home. The average property value for this pool was over $625k and there is a large distribution of loans with very high property values relative to those in the Alt-A model's data set. Because this variable is not considered in the Alt-A model, PDs are higher for these loans than what the data suggests.
The aggregate impact of these adjustments resulted in losses approximately 2 notches lower than unadjusted legacy Alt-A model output.
Fitch's analysis incorporates a sensitivity analysis to demonstrate how the ratings would react to steeper market value declines (MVDs) than assumed at the 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 may be considered in the surveillance of the transaction. Two sets of sensitivity analyses were conducted at the state and national levels to assess the effect of higher MVDs for the subject pool.
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 6.4%. The analysis indicates that there is some potential rating migration with higher MVDs, compared with the model projection.
Fitch also conducted sensitivities to determine the stresses to MVDs that would reduce a rating by one full category, to non-investment grade, and to 'CCCsf'.
Fitch's stress and rating sensitivity analysis are discussed in its presale report released today 'COLT 2016-3 Mortgage Loan Trust', available at 'www.fitchratings.com' or by clicking on the link.
USE OF THIRD-PARTY DUE DILIGENCE PURSUANT TO SEC RULE 17G-10
Fitch was provided with Form ABS Due Diligence-15E (Form 15E) as prepared by AMC Diligence, LLC (AMC) and Deloitte & Touche LLP (Deloitte). The third-party due diligence described in Form 15E focused on three areas: a compliance review; a credit review; and a valuation review; and was conducted on 100% of the loans in the pool. Fitch considered this information in its analysis and believes the overall results of the review generally reflected strong underwriting controls. Fitch made the following adjustment(s) to its analysis: A total of five loans were identified as having material exceptions which are potentially at risk for statutory damages and were subject to an increase in Fitch's LS of $15,500 to account for the possible maximum statutory damage awarded to a borrower ($4,000); borrower legal costs associated with the TRID violation ($10,000); and the trust's incremental legal costs associated with the error ($1,500). Fitch received certifications indicating that the loan-level due diligence was conducted in accordance with its published standards for reviewing loans and in accordance with the independence standards outlined in its criteria.
REPRESENTATIONS, WARRANTIES AND ENFORCEMENT MECHANISMS
A description of the transaction's representations, warranties and enforcement mechanisms (RW&Es) that are disclosed in the offering document and which relate to the underlying asset pool is available by accessing the appendix referenced under "Related Research" below. The appendix also contains a comparison of these RW&Es to those Fitch considers typical for the asset class as detailed in the Special Report titled 'Representations, Warranties and Enforcement Mechanisms in Global Structured Finance Transactions,' dated May 2016.
Additional information is available at www.fitchratings.com.
Sources of Information:
In addition to the information sources identified in Fitch's criteria listed below, Fitch's analysis incorporated data tapes, due diligence results, deal structure and legal documents provided on the transaction's 17g5 website available on 'www.17g5.com'.
Counterparty Criteria for Structured Finance and Covered Bonds (pub. 01 Sep 2016)
Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds (pub. 26 Oct 2016)
Global Structured Finance Rating Criteria (pub. 27 Jun 2016)
Rating Criteria for U.S. Residential and Small Balance Commercial Mortgage Servicers (pub. 23 Apr 2015)
U.S. RMBS Cash Flow Analysis Criteria (pub. 15 Apr 2016)
U.S. RMBS Loan Loss Model Criteria (pub. 29 Nov 2016)
U.S. RMBS Master Rating Criteria (pub. 01 Dec 2016)
U.S. RMBS Surveillance and Re-REMIC Criteria (pub. 15 Nov 2016)
COLT 2016-3 Appendix
Dodd-Frank Rating Information Disclosure Form
ABS Due Diligence Form 15E 1
ABS Due Diligence Form 15E 2
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