Residential transition loan (RTL) securitizations, after hitting the market in 2018, have always appealed to residential real estate investors seeking bridge loan capital as they purchase and prepare properties for profitable resales. In February, Toorak Capital Partners, a non-bank lender specializing in single- and multi-family properties, completed the first-ever rated RTL securitization, which changed the sector.
It further validated the product's viability in the securitization market, enabling issuers to upsize the Morningstar DBRS rated deal to $240 million, from $192 million in pre-marketing, for instance.
Backed by $250 million in collateral, the transaction was quickly followed by two more. and the RTL-deal pipeline is anticipated to remain healthy. In April Genesis Capital followed with a$500 million rated RTL securitization, and a month later New York Mortgage Trust came forward with a $250 million deal.
"We have a robust pipeline of RTL engagements and anticipate more deals this year," said Corina Gonzalez, associate managing director, U.S. RMBS ratings, at the rating agency.
The rated deals provide issuers with less expensive financing for certain types of residential-mortgage loans, and investors with an attractive investment in today's uncertain interest-rate environment.
We did an unrated deal earlier in the year, and the yield on the rated deal was materially lower.
RTLs are generally short-term, interest-only bridge loans enabling real-estate investors to purchase and prepare residential properties to sell for a profit. After the first large RTL securitization was completed in 2018, the market has grown significantly, approaching $10 billion in estimated volume in 2022, says Mayer Brown in a June 2023 report. RTLs should remain popular, especially in conditions where new housing stock is in short supply.
RTL securitizations were unrated until Morningstar DBRS finalized its ratings methodology for the asset class last year, enabling Toorak Capital Partners to be the first to market with a rated deal.
The transactions are distinguished from traditional residential mortgage-backed securities (RMBS) by their revolving structure and comparatively short maturity. Morningstar DBRS rated all three of the early deals.
Toorak has completed more than $3 billion in securitizations overall across 12 deals, including eight unrated transactions backed by RTLs. It anticipates issuing at least one more rated RTL securitization this year, according to John Beacham, CEO of Toorak.
"We did an unrated deal earlier in the year, and the yield on the rated deal was materially lower," Beacham said. "We saw a lot of interest from investors who couldn't buy the unrated bond."
The single-A tranche pays a coupon of 6.597%, and the BBB 7.568%. The combined class A notes priced for a spread of 210 basis points over SOFR, compared to 325 basis points for Toorak's earlier, unrated RTL securitization.
Beacham noted that RTLs are short-term loans, with an average life of approximately one year. To allow issuers to amortize the fixed issuance costs over a longer period, the deals are structured with a revolving component to stretch out the average life—two years in the case of Toorak's deal, which holds a legal maturity of February 2029. Payoffs of the underlying loans are then dedicated to paying down the bonds, spurred further toward the end of year three by a 100-bps rate step up.
Mayer Brown notes that the higher cost of RTL securitizations to borrowers stems in part from the "inherently increased risks and sometimes speculative nature of the underlying property improvement projects." Nevertheless, the securitizations' shorter average lives offer less prepayment risk than traditional residential mortgage-backed securities with significantly longer average lives.
"It's a new asset class that pays a premium, but it also offers a really different type of instrument that's much more predictable—much shorter—than what's otherwise available in residential mortgages," Beacham said.
Morningstar DBRS currently caps the highest rated RTL securitization tranches at single-A, typically the case among rating agencies for new asset classes.
"We may assign higher ratings in the future, once the space becomes more mature and has more rated deal performance," Gonzalez said.
Beacham added that Morningstar DBRS's methodology requires rated RTL securitizations to pool loans for one-to-four family residences.
"We expect securitizations pooling one-to-four family loans to be rated, and those pooling loans that don't fit into that box to be unrated," he said.
