Some features designed to make the safest private-label mortgage bonds even safer may not be such a sure thingl, according to Moody’s Investors Service.
It said these securities "pose analytical challenges," suggesting that it does not agree with the assessment of rival credit rating agencies.
Some recent residential mortgage securitizations have structural features, more common before the financial crisis, that offer more than one kind of senior bonds. While all of the senior bonds typically carry the highest investment grade rating, they are not equally safe and are priced accordingly.
These features include "super senior support bonds," which provide an additional layer of protection for an even more senior class of bonds, as well as exchangeable securities, principal-only bonds, and pool interest-only bonds.
Moody’s said these securities “pose analytical challenges” because their risk profiles are affected not only by the absolute level of losses and prepayments on loans used as collateral, but by the timing of losses and prepayments.
The agency didn’t cite specific deals, but Shellpoint Partners, the lender founded by mortgage-bond pioneer Lewis Ranieri, restructured the senior tranche of its initial RMBS deal that priced in June. It has two classes of super senior notes with credit enhancement of 20%; they are supported by a senior class that has credit enhancement of 10.10%. All three were rated ‘AAA’ by Standard & Poor’s and Fitch Ratings. Moody’s did not rate the deal.
Moody’s noted that, in high-loss scenarios that wipe out the subordinate bonds, super senior support bonds can incur vastly higher losses than the super senior bonds they support. In particular, some support bonds provide additional protection to the super senior bonds by foregoing principal allocations until the super senior pays down, while others share the principal pro rata.
Because the support bonds are typically small relative to the super senior bonds, they could incur a very high loss severity because any losses that the support bonds incur will constitute a large percentage of the support bond’s balance, the agency said.
“Given that our ratings reflect not only the probability of a bond’s default but also the severity of the loss in the event of the default, a support bond’s small size means that it might need more enhancement than a larger bond would to achieve a particular rating at a given pool expected loss.”
Moody’s noted that other features that have not yet returned but were common in pre-crisis transactions, such as non-accelerating senior bonds and planned and targeted amortization classes, also expose bonds to tail risks in high-loss scenarios.