Rating agencies are talking tough about residential mortgage backed securities (RMBS) again.

This time the fuss isn’t about selling defective loans back to the originators. Instead, raters disagree about the risk of deals with a large number of mortgages on homes in the same state, or even the same city.

At issue is a $440 million offering of residential mortgage backed securities by Nomura Corporate Funding. It is Nomura's first RMBS since the financial crisis and is backed entirely by 30-year, fixed-rate loans originated by First Republic Bank, a jumbo lender with a strong performance history. First Republic loans also back a number of Redwood Trust’s RMBS.

Kroll Bond Rating Agency and Standard & Poor's have assigned a triple-A rating to the senior tranches of Nomura’s deal. They did this despite the fact that the deal has a higher geographic concentration than any RMBS issued since the financial crisis. Seventy-five percent of the mortgages are on properties in California.

Both rating agencies said the creditworthiness of the borrowers helps offset the risk that a decline in housing prices in California could hurt the performance of the deal.

Fitch Ratings disagrees. In an unsolicited comment, it said the deal’s credit enhancement is insufficient to achieve a triple-A rating.  The agency has no problem with the credit quality of the loans, which have a weighted average FICO score of 770 and an average combined-loan-to-value ratio of 65.6%.

But Fitch thinks that too many of them are in California, particularly in some parts of the state where it feels housing prices are overvalued. As a result, it would apply a 75% increase to the default frequency assumption for this pool, if asked to rate the deal. This means that the credit enhancement for the senior class would need to be between 9% and 10% in order to achieve an 'AAA' rating.  The transaction is currently structured with credit enhancement of 7.6%. 

“While the attributes of the underlying pool are strong, Fitch believes that meaningful risk is introduced with concentrations of loan production. This contributed to Fitch’s perception that higher credit enhancement is needed for NRPMT 2013-1 as compared to other high quality securitizations,” managing directors Roelof W. Slump and Rui Pereira said in the report.

Moody’s Investors Service and DBRS have yet to comment on the transaction.

Kroll also sees geographic concentration as an important risk factor. In a presale report published Tuesday, the rating agency said that it took this into account in rating the deal, applying a 67% increase to the default frequency assumption for the pool. But analysts feel that the credit quality of the collateral is so high that credit enhancement of 7.6% is sufficient to justify the ‘AAA’ rating.

“A significant portion of the borrowers exhibit high levels of verified assets, and most loans demonstrate prudent debt-to-income ratios, especially given relatively high borrower incomes,” Kroll said in its presale report.

Kroll also took into account First Republic's experience as a jumbo mortgage lender and servicer.

“If you look at the performance history of First Republic collateral, it’s one of top performing” originators, Michele Patterson, the primary Kroll analyst on the deal, said in a telephone interview. “Some of these borrowers have $1 million in reserves. If there are any issues, borrowers can continue to pay the mortgages,” she said.

Glenn Costello, a senior managing director at Kroll, noted that First Republic's mortgage origination has always been concentrated in California, even during the financial crisis. "We can see how it performed when hit with very severe home price declines," he said in the same telephone interview.

Another mitigating factor, accoring to S&P, is that due diligence was performed on 100% of the loans in the pool by a third-party due diligence provider from its of reviewed providers, which encompasses regulatory compliance, credit underwriting compliance, property valuations, and pay history reviews. "The results are consistent with high-quality underwriting," it said in its presale report.

Unlike some RMBS issued this year, assurances as to the quality of the loans backing this deal are not being disputed. A $616 million RMBS issued by JP Morgan in March drew criticism from Moody's, which said it was too easy for originators, including First Republic, to avoid buying back defective loans. Fitch and Kroll both assigned top ratings to the deal, saying that its additional credit enhancement offset any concerns about the qualify of so-called representations and warranties.

Kroll noted in its report that Nomura's deal has no "sunset provision" releasing First Republic from a requirement to repurchase defective loans after a certain date. Some recent deals with such a provision attracted criticism from rating agencies.  


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