In another sign of strong demand by investors for nonperforming residential mortgages, the asset class is edging closer to more rated, public securitizations — a rarity in this largely opaque market.
Brian Grow, managing director of RMBS at Morningstar Credit Ratings, said the queries the firm is receiving on rating this asset class have gone up in the last year, and “issuers are getting more specific in their questions.”
Regardless of whether the deals obtain credit ratings, issuance is expected to grow this year. In a Sept. 21 report, analysts at Bank of America Merrill Lynch predicted roughly $18 billion of nonperforming (NPL) and reperforming (RPL) securitizations this year, up from $14.7 billion in 2013. About $12.4 billion has been placed so far in 2014.
Reaching a new investor base is the main impetus to getting a rating.
“Securitizers of NPLs and RPLs will seek ratings on their deals if they want to reach investors that need investment grade ratings to avoid high capital charges,” said Kevin Dwyer, senior vice president at Morningstar.
The pool of potential collateral is unquestionably vast, as servicers are still working out mortgages damaged during the crisis. BAML analysts estimates that are about $1.12 trillion outstanding NPLs and RPLs, split evenly between them.
The GSEs are big holders of these loans, with 24.4% of RPLs by volume and 20.4% of NPLs, according to data from BAML using a range of sources. Portfolio investors, which include banks as well as nonbanks in the private sector, have about 28.9% and 36.6%, respectively.
The Department of Housing and Urban Development (HUD) has been a major supplier, selling massive chunks under its “Single Family Loan Sale Initiative” started in 2010. The agency had gobbled up billions in NPLs — a March report from Barclays capital said its current holdings were around $90 billion — and it has been peddling these loans to investors via periodic auctions. HUD sold about $13 billion in NPLs in 2013, and has held auctions this year as well, the most recent taking place on Sept. 30 for $2.3 billion.
Prices for HUD’s loans have gone up in the past couple of years, with some players at Sourcemedia’s Distressed Mortgage Summit in late June going so far as to argue that the market was overheated.
Part of the reason could be that newer kinds of investors have been coming into this market as yields on legacy non-agency mortgage bonds keep sliding. Banks have also been major sellers of NPLs.
Barclays believes that the market supply of loans could jump if the GSEs start to offload their NPLs more aggressively. Bloomberg reported that Freddie Mac sold $659 million in NPLs this past August.
The leading securitizers of these loans have been non-bank entities with a strong background in servicing, a requirement for dealing with this class of loans. These include Carrington Mortgage Services (via its Stanwich vehicle), Vericrest Financial, and Blackstone affiliate Bayview Asset Management.
As Barclays analysts point out, “maximizing returns on the NPL investment requires maximum the recovery value of NPLs, which means working closely with the borrower to find the best solution. Hence, servicers’ expertise in handling delinquencies can make a significant difference to the NPL pools’ recovery value.”
Even RPL loans need significantly more attention than loans that have always been current. A September report from Moody’s Investors Service found that it takes about 36 months for the default probability of an RPL to fall in line with that of a never-delinquent loan that has an LTV of over 100.
Carrington, Vericrest and Bayview, along with other securitizers of NPLs/RPLs apparently have encountered enough demand to issue deals unrated.
But at least one attempt to obtain a rating this year ran into trouble. Only a few days after putting out a presale in late April, Standard & Poor’s withdrew its ratings on Bayview Opportunity Master Trust Fund IIIa Trust 2014-9RPL when the deal was delayed following the agency’s request for “additional information pertaining to property valuations and loss severity experience.”
S&P’s experience underlines the particular challenges this asset class poses.
“The loans can be many years old, and often have been traded multiple times, so some of the original data may be lost,” Dwyer added. “Payment history and updated data such as FICO and property value are more important.”
In addition, NPL/RPL mortgages generally do not have updated full appraisal property valuation. Dwyer said that either analysts have to get comfortable with broker price opinions (BPOs) or they have to size the enhancement for what they might consider a sub-par appraisal.
Whatever players decide to do in terms of rating, some observers believe securitizations will continue, with Barclays predicting that as more sales enter the market — by HUD, banks or the long-awaited GSEs — an increase in securitization volume will likely follow suit.