Fannie Mae on Monday launched its first transaction offloading credit risk on mortgages it insures using a real estate mortgage investment conduit (REMIC).
To date, Fannie has primarily obtained reinsurance through its benchmark Connecticut Avenue Securities program using a kind of credit-linked note. The performance of the securities issued to date is linked to a reference pool of mortgages, but they are the general obligation of the government-sponsored enterprise.
In contrast, the notes in the new transaction, Connecticut Avenue Securities 2018-R07, will be issued by a bankruptcy remote trust. (Fannie facilitated this change by making a REMIC tax election on a majority of single-family loans that it acquires and guarantees, effective May 1.) Proceeds will be invested in various investment accounts, rather than sitting on Fannie’s balance sheet.
This accomplishes two things: it reduces the risk, however remote, that Fannie would fail to repay the bonds. Equally important, using a REMIC structure expands the potential investor base for Connecticut Avenue Securities, making the program more attractive to real estate investment trusts as well as certain other investors.
Investors still risk forgoing interest payments, or even losing some or all of their principal, should losses on loans in the reference pool reach a predetermined amount. But they no longer have to worry about whether Fannie will have enough money to repay them if losses on the reference pool are low.
This change appears to have had relatively little impact on rating agencies’ views of the risk of the new notes. Fitch Ratings and Kroll Bond Rating Agency expect to assign ratings that are largely in line with their view of the previous Connecticut Avenue Securities deal, which was structured as a general obligation. The 1M-2C tranche of the new deal, which benefits from just 1.25% credit enhancement, is rated B by Fitch and BB by Kroll, unchanged from the prior transaction.
Likewise, ratings on the 1M-2B tranche with 2.12% credit enhancement are unchanged at BB-/BBB; and ratings on the 1M-2A tranche with 2.98% credit enhancement are unchanged at BB/BBB.
Fitch’s view on the 1M-1 tranche with 3.85% credit enhancement is unchanged at BBB-; however, Kroll takes a slightly more positive view, rating it A+, one notch higher than the A on the comparable tranche of the prior deal.
The reference pool for CAS 2018-R07 consists of 98,567 fully documented, fully amortizing, fixed-rate mortgages of prime quality with an aggregate unpaid principal balance of approximately $24.3 billion.
The borrowers in CAS 2018-R07 have a weighted average (WA) credit score of 742 and a WA debt-to-income ratio of 37.5%, which are consistent with prime-quality underwriting. The pool has a WA loan-to-value ratio of 75.7%, with 70.4% of the mortgages possessing LTVs of 75% to 80%. Approximately 3.8% of the loans possessed subordinate financing at origination, contributing to the pool’s WA combined loan-to-value ratio of 76.3%.
Primary residences, second homes and investment properties make up 84.1%, 5.5% and 10.5% of the reference obligations, respectively. Approximately 61.9% of the pool consists of purchase loans, while 10.1% and 28.0% of the mortgages were originated for rate/term refinancing and cash-outs, respectively. The WA loan age for the CAS 2018-R07 Reference Pool was approximately 2.7 months at deal issuance.
In its presale report, Kroll notes that the both the weighted average LTV and CLTV are higher than most of the recent nonagency prime RMBS transactions that it has rated. Kroll views higher levels of equity in the property to be among the best deterrents of default, particularly when home prices come under stress
And, typical of credit risk transfer transactions, the CAS 2018-R07 reference pool exhibits significantly more geographic diversification than most prime jumbo RMBS pools. “Geographic diversity helps mitigate the risk that a regional economic recession or natural disaster will have an outsized impact on default rates,” the presale report states. “When considering the average California percentage in Kroll-rated prime jumbo pools (approximately 45%-50%), the California concentration in CAS 2018-R07 is relatively low at 19.7%.”
Fitch notes that CAS credit attributes are weakening relative to CAS transactions issued several years ago. Compared to the earlier post-crisis vintages, this reference pool consists of weaker FICO scores and debt-to-income ratios. The credit migration has been a key driver of Fitch’s rising loss expectations, which have moderately increased over time.
Both rating agencies note that approximately 2.5% of the reference pool was originated under Fannie Mae’s HomeReady program, which targets low-to-moderate income homebuyers or buyers in high-cost or underrepresented communities and provides flexibility for a borrower’s LTV, income, down payment and mortgage insurance coverage requirements. Fitch anticipates higher default risk for HomeReady loans due to measurable attributes (such as FICO, LTV and property value), which is reflected in increased credit enhancement.
