American Homes 4 Rent’s latest securitization, AH4R SFR 2015-1, addresses one of the biggest risks inherent in bonds backed by single-family rental properties: the possibility that the loans backing these deals cannot be refinanced at maturity.
The rental home securitizations that have been issued so far are backed by a single loan that is backed in turn by thousands of properties. To date, the loans backing most transactions have five- or 10-year terms, and many of them pay only interest for their entire terms. This begs the question of how difficult it will be to refinance the loans at maturity, particularly if the housing prices drop, reducing the value of the collateral, and the loan has not amortized.
AH4R 2015-SFR1 avoids this problem with afeature more commonly used in securitizations of single large commercial mortgage. The deal is backed by a 30-year loan with an anticipated repayment date of 10 years.
The triple-A rate, class A bonds pay swaps plus 140 basis points, the double-A plus rated, class B bonds pay swaps plus 170 basis points and the single A plus rated, class C bonds pay swaps plus 200 basis points. Kroll Bond Rating Agency, Moody’s Investor Service and Morningstar rated the tranches.
Further down the curve, the A-/ Baa2’/ BBB+’ rated class D notes pay swaps plus 355 basis points. The BBB-/ BBB’ rated class E notes pay swaps plus 355 basis points and the class F notes, rated BB’/ BB+’, pay swaps plus 380 basis points. Moody’s did not rate the class E and F notes.
With a legal maturity of April 2045, the loan would technically be more susceptible to term default than loans of comparable credit quality with shorter terms. That is because longer term loans have more payments over which a default can occur.
However the loan’s anticipated repayment date (ARD) of 2025 means that it functions more like the 10-year loans in prior American Homes 4 Rent deals, with some added flexibility.
“The ARD basically gives the issuer the option to extend the loan. At the end of a 10-year period, instead of having a maturity where you have to pay the bonds back, there is an ability to extend the term of the bonds,” said Kevin Dwyer, senior vice president at Morningstar.
"Operation and refinancing are the two biggest risks to this relatively new asset class,” said Navneet Agarwal, a managing director at Moody’s. “We only have one counterparty that is borrowing the money, and while the borrower does not have 100% probability of default, the default risk is binary. As a result, we rate the transaction to a liquidation scenario. ARD alleviates some of this refinancing failure driven liquidation risk."
American Homes 4 Rent’s previous two deals, AH4R 2014-2 and AH4R 2014-3 both featured 10-year terms and pay both principal and interest for their entire terms.
Over the first 10 years of the life of AH4R SFR 2015-1, any cash flows remaining after servicing the portfolio and meeting interest and amortization payments, go back to the sponsors; after the ARD the cashflows no longer go to sponsor.
“Essentially what it does is it get rid of an event of default and makes the deal hyper-amortize,” said Agarwal. “Should the issuer not refinance on the ARD, any cashflows that will remain after servicing the underlying portfolio goes toward repayment of the debt," he said.
Of course, there’s a downside to the longer term of the loan backing AH4R SFR 2015-1: it exposes investors to a greater risk of deterioration in both home prices and sponsor performance, as well as an increase in expenses that may arise.
Brian Grow, a managing director on the RMBS team at Morningstar, said that this is a risk inherent in all single-family rental deals. As part of Morningstar Credit Ratings’ analysis for the transactions, the cash flows and house values are stressed to a level where bondholders would still get paid every month and at expected maturity.
“We value at a level where there is enough equity in the houses even after all the stresses so that if they had to be sold as a portfolio or as individual properties, they would generate enough cash to pay the full principal —regardless of whether that is a property manager finding refinancing, finding a portfolio purchaser or liquidating the properties,” said Grow.
But he added that it could be argued that the house price scenario is less important for American Homes 4 Rent, because it is likely that over a period of 30 years there will be periods when housing prices are strong enough to make refinancing feasible.